“To this point, the Fed remains firm that it wants to see inflation down to its 2% target,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. Freedman says inflation’s “stickiness” makes the Fed somewhat cautious about when it begins cutting interest rates. Given inflation’s persistence in the 3% range and an economy that has proved resilient despite higher interest rates, “There’s enough cover right now for the Fed to sit tight,” says Freedman.
The Fed’s preferred inflation gauge, the PCE price index, is a measure of the spending on goods and services. This again offered little encouragement for investors eager for the Fed to begin cutting rates. The headline PCE index ticked up to 2.7% for the one-year period ending in March 2024 (compared to 2.5% in February and 2.4% in January). The narrower “core” PCE (excluding the volatile food and energy categories) rose 2.6% over the same period, a slight drop from February.6 Again, both numbers are well above the Fed’s long-term 2% target.
“To this point, the Fed remains firm that it wants to see inflation down to its 2% target,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. Freedman says inflation’s “stickiness” makes the Fed somewhat cautious about when it begins cutting interest rates. Given inflation’s persistence in the 3% range and an economy that has proved resilient despite higher interest rates, “There’s enough cover right now for the Fed to sit tight,” says Freedman.
The fed funds target rate, managed by the Fed’s policy-making Federal Open Market Committee (FOMC), is 5.25% to 5.50%, up from close to 0% as recently as two years ago. The Fed has maintained the target rate at that level since July 2023. In that time, bond yields rose commensurately across the board. The benchmark 10-year U.S. Treasury note stood at 4.98% on October 18, then fell below 4% in late December as investors began to anticipate Fed rate cuts. However, 10-year Treasury yields have, in 2024, remained firmly above 4%. “The markets initially anticipated an early start to Fed rate cuts in 2024,” says Haworth. The latest data appears to dampen expectations for interest rate cuts until later in the year. “Nevertheless, markets appear to believe that the Fed is on track to temper inflation, even if it takes a little longer than initially expected.”
How inflation can impact your portfolio
At a time when inflation began to slow from its peak in mid-2022, stocks performed better. In early 2024, the S&P 500 stock index reached new highs. While bond yields are below peak levels reached in October 2023, the bond market continues to offer attractive yields for long-term investors. Although yields on some shorter-term securities exceed yields of some longer-term bonds, Haworth says investors should consider placing more emphasis on their ultimate portfolio goals. “It may be an appropriate time to move money out of short-term vehicles and focus on positioning your portfolio in assets, such as stocks and longer-term bonds, that can help you achieve your ultimate financial objectives in the years to come.”
“We may not yet be seeing the massive disinflationary environment many are looking for,” says Freedman, “but’s it’s still an environment where we think you can own stocks, as opposed to getting more bearish.”
Haworth notes that the stock market has been on an upswing since late 2022. “In general, stock markets can perform well in either a high or low-rate environment, but it is periods of transition from one environment to the next that can cause more significant price swings.”
Haworth says the persistent inflationary environment creates some challenges for bond investors. As a result, U.S. Bank’s Asset Management Group currently recommends investors tilt portfolios toward equities and real assets and away from traditional fixed income.
Generally, a consistent long-term strategy tends to work to the benefit of most investors. This likely precludes any dramatic changes to your asset allocation strategy in response to persistently elevated inflation.
Be sure to talk with your financial professional about what steps may be most appropriate for your situation.