“That’s a favorable signal,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “Yet to this point, the Fed remains firm that it wants to see inflation down to its 2% target.” 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, “There’s enough cover right now for the Fed to sit tight,” says Freedman.
Today, 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. Bond yields across the board rose commensurately in that time period. The benchmark 10-year U.S. Treasury note stood at 4.98% on October 18, but fell below 4% in late December before settling above the 4% level in early 2024. “The markets began to anticipate an early start to Fed rate cuts in 2024,” says Haworth. At its January 2024 meeting, Fed chair Jerome Powell indicated that cuts to the target federal funds rate were likely in 2024. He added however, that the policy making Federal Open Market Committee “does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”6
Inflation triggers
Inflation measures provide a sense of how much purchasing power is lost due to rising prices. CPI is the commonly cited statistic used to reflect inflation on a broad scale. CPI provides a measure of prices for goods and services that meet the primary needs of consumers, including food items, transportation, housing and medical care.
While temporary supply chain disruptions may have triggered a resurgence of inflation in 2021, there’s been more focus recently on contributing factors such as rising wage costs and increased demand for services, especially travel and entertainment. “With workers earning higher pay, it feeds into higher demand, reflected today in the service segment of the economy, and that is propping up inflation even as prices for some goods decline,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management.
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 says as long as inflation stays sufficiently high to prevent the Fed from cutting interest rates, it puts some sectors at a disadvantage. “There are certain segments of the stock market hurt by higher interest rates, such as utility and real estate stocks,” says Haworth. He notes, however, that the stock market as a whole 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.”
The bond market is affected by inflationary news as well, since bond yields, over time, tend to track with inflation. “The bond market has to factor in what the Fed’s reaction is going to be as the economy remains robust,” says Haworth. “And that’s higher interest rates for longer, which could mean bond yields potentially move higher across the board.”
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.