US inflation has jumped to 4.2%, the highest reading in three years, and the market’s assumption that the Federal Reserve is edging toward lower interest rates has been dealt a serious blow, warns Nigel Green, CEO of global financial advisory deVere Group.
The consumer price index for May was expected to show a 4.2% gain from a year ago, according to the Dow Jones consensus estimate.
But the chief executive argues: “Just because the inflation numbers came in consistent with expectations doesn’t mean they are good.
“Indeed, it’s the first major inflation test facing newly installed Fed Chair Kevin Warsh, strengthens the case for a more hawkish central bank, and leaves investors dangerously exposed if they continue to underestimate the inflation threat.”
The timing could hardly be more significant.
Kevin Warsh heads into his first Federal Open Market Committee meeting as chairman with inflation accelerating, oil prices rising and the US economy continuing to show resilience.
Investors who expected the new Fed chief to inherit a rate-cutting cycle are instead confronting a markedly different backdrop.
Warsh begins his tenure facing the fastest inflation rate in three years and growing evidence that price pressures remain stubbornly embedded across the economy.
Nigel Green continues: “Many investors assumed Warsh’s first meetings would revolve around the timing of rate cuts. Inflation has changed that calculation.
“A 4.2% CPI today reading puts the focus squarely back on price stability.
“Warsh understands that credibility is earned early. He is unlikely to begin his chairmanship by signalling comfort with inflation moving further away from target.”
The latest consumer price data marks a sharp acceleration from April’s 3.8% annual reading.
Core inflation also moved higher, underlining concerns that underlying price pressures remain persistent despite expectations earlier this year that inflation would continue to moderate.
The report arrives against a backdrop of strong employment, resilient consumer spending and rising energy costs. Oil prices have climbed amid heightened geopolitical tensions, adding another layer of inflationary pressure at the moment policymakers had hoped price growth was moving back under control.
“Inflation has reasserted itself in a way the Fed can’t ignore.
“Markets have spent months building a narrative around lower rates. Today’s figures demand a fundamental reassessment.
“The economy remains remarkably resilient, employment remains strong, consumer demand remains healthy, and inflation is accelerating.
“There’s almost no way the Fed can justify any shift towards easier policy.
“Markets are being forced to abandon the comfortable assumption that lower rates are around the corner.
“Investors are steadily pushing back expectations for policy easing and, increasingly, are having to consider the possibility that the next move from the Fed is not down but up.
“Inflation at 4.2% makes that a conversation nobody can afford to ignore.”
The implications stretch across global markets. Higher US interest rates typically support the dollar, increase borrowing costs and tighten financial conditions worldwide.
Sectors that have benefited from expectations of lower rates could face renewed pressure if investors continue adjusting to a more hawkish outlook from the world’s most influential central bank.
Despite the inflation setback, Nigel Green believes opportunities remain for investors prepared to adapt.
“Periods of market adjustment create opportunities for disciplined investors.
“Quality businesses with strong balance sheets, durable earnings and pricing power become increasingly attractive in this environment.
“The investment environment is changing, and savvy investors will respond accordingly.”
Nigel Green concludes: “Investors now should be eyeing the bigger issue of the signal Kevin Warsh sends about the direction of policy over the coming months.
“Inflation at 4.2% leaves little room for complacency.
“My view is that the balance of risks has shifted materially. The conversation is moving away from when rates are cut and toward how long restrictive policy remains necessary.
“Investors who continue to dismiss that possibility are taking an increasingly dangerous gamble.”
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