Inflation Heats Up as Fed Decision Looms

Sep 13, 2023

Higher energy prices provided the fuel for a hotter-than-expected report on US consumer inflation Wednesday, adding to a mixed bag of economic indicators as the Federal Reserve prepares for its September meeting. The consumer price index gained 0.6% in August when compared against the prior month, the biggest jump since June 2022. Prices were up 3.7% year-over-year, a notch above the consensus estimate and higher than July’s 3.2%. With oil futures recently climbing to their highest levels of the year, gasoline accounted for more than half of inflation’s monthly increase. Core prices, which exclude energy and food, also picked up pace from July, even as they cooled on a yearly basis. Readings on producer prices and retail sales Thursday also exceeded forecasts, indicating that inflationary pressure and consumer spending may have been more resilient than anticipated. Across the Atlantic, the European Central Bank raised rates to a record high in its own battle with stubborn inflation.

BOND RETURNS AROUND END OF RATE HIKE CYCLES

For illustrative purpose only. Source: Morningstar and Bloomberg. Average annualized returns 1 year and 3 years before or after last Fed rate hike of the last four cycles (1994-2021). 0 represents month of last rate hike. Data for Morningstar Intermediate Core-Plus Bond Category average. Past performance does not guarantee future results.

In the months ahead, the Fed will be tasked with judging the strength of underlying price pressures and whether inflation is on a sustainable path toward the central bank’s 2% target. Market participants widely expect policymakers to hold the line next week but are more split on the chances of a rate hike at the two final meetings of the year, the CME Group’s FedWatch Tool showed. With the end of the Fed’s rate-hike campaign likely on the horizon, bond markets may be close to an inflection point. During 1994 to 2021, buying bonds near the end of hiking cycles resulted in stronger returns than waiting to invest, according to data compiled by PGIM Investments. Over the past four tightening cycles, waiting longer to allocate after the final rate hikes led to lower returns in the subsequent one- and three-year periods.