Macro Insights: Inflating inflation fears

Broader expectations last year were inflation will fall back towards target in 2023, allowing central banks to cool down their pace of policy tightening. We have been in the inflation higher-for-longer camp since the days it has been called “transitory”, and a rude awakening for the markets is happening now bringing inflation expectations higher. January inflation data for the US and the Eurozone came in hot, fueling bets that central banks will have to do more to bring prices under control. Meanwhile, wages remain high due to the demand/supply imbalance in labor market further aggravating inflation concerns.

US inflation concerns aggravate

Fed’s preferred inflation gauge, the PCE deflator, came in hotter-than-expected for January. In addition, upward revisions to the previous month’s prints sent a strong hawkish signal to the markets reinforcing the Fed’s higher-for-longer message. Core PCE rose 4.7% YoY, accelerating from the upwardly revised 4.6% and above the expected 4.3% and the Fed’s target of 2%. The MoM rose 0.6%, hotter-than-expected and upwardly revised prior of 0.4%. This comes on top of a hot January CPI as well as PPI, all together underscoring persistent inflationary pressures and the need for the Fed to continue hiking rates.

Supply chain disruptions easing, but risks won’t go away

The cost of shopping containers have retreated from the covid-era peaks. Spot rates from Asia to the US West Coast, which increased more than 15-fold during the pandemic, have since returned to pre-Covid levels. Still, prices remain significantly higher that the pre-covid times, such as the short-term prices for containers from Europe to the US East Coast are still more than double what they were in late-2019.

More importantly, risks remain elevated amid a rapidly deglobalizing world. The geopolitical tensions never went away since the year-ago Russian invasion of Ukraine, but have accelerated meaningfully again the last few weeks as we approached the one-year anniversary of the war. Alongside, rising tensions over Taiwan and the US-China relations have become an increasing focus. So even if spot prices in shipping are easing, the contracts have been renegotiated at higher prices in 2021 and 2022 at much higher rates, and the potential for discount remains limited for now given the high risk environment. That is a key reason why the disinflation in goods prices, which was highlighted by Chair Powell at the February FOMC, has quickly reversed and remains volatile at best. It’s hard to get comfortable about the trend in goods inflation, let alone the surging services inflation.