By While investors are optimistic about a favorable economic outlook in 2024, there is a looming concern that inflation and interest rates could disrupt this idyllic scenario.
According to renowned economist Torsten Sløk, the notion that inflation has been completely tamed is misleading. Fed rate hikes have indeed had a negative impact on the economy, particularly evident in cyclical industries such as housing. Despite this, the decline in these sectors was overshadowed by the strength seen in noncyclical components, such as travel and leisure.
The interest rate-sensitive parts of the economy, notably the housing market, suffered greatly from the aggressive rate increases implemented by the Fed. As a result, housing inflation plummeted. Considering that housing holds a significant weight of 40% in the consumer price index (CPI) basket, this decline in inflation has contributed to the overall decrease in headline and core inflation.
However, while inflation has technically fallen, many individuals continue to grapple with high prices across various goods and services. This confounding situation arises from Americans’ eagerness to resume activities that were put on hold during the pandemic, like dining out and going on vacations. Consumer spending, accounting for two-thirds of U.S. GDP, has undoubtedly contributed to the resilience of the economy. Additionally, strong economic data coupled with expectations of upcoming rate cuts have bolstered market performance.
In light of these developments, Sløk predicts that the economy will regain momentum in the coming months, subsequently exerting upward pressure on inflation. This concern over inflation will likely influence the Federal Reserve to maintain a more hawkish stance than desired by some individuals.
The Ongoing Battle Against Inflation
According to an expert, the Federal Reserve is far from finished in its fight against inflation. Consequently, it is premature to claim that we are experiencing a soft landing, as both the cyclical and non-cyclical elements of GDP are anticipated to remain robust in the coming months.
Naturally, this news might not be ideal for investors, despite the positive outlook for the near-term economy. This is because the market has already factored in expectations of rate cuts from the Fed, and failure to deliver on these expectations could have negative consequences.
Recent data supports the notion that the battle against inflation is ongoing. In December, the Consumer Price Index (CPI) revealed a year-over-year price increase of 3.4%. Additionally, statements made by Fed speakers about an extended period of higher interest rates have dampened hopes for looser monetary policy, creating a drag on the stock market since the beginning of the year.
This disparity between expectations and reality could lead to market volatility at the very least. Furthermore, if long-term tightening policies begin to impede economic growth, it could jeopardize the prospects of a soft landing and potentially trigger a downturn. These concerns, coupled with potential political headwinds both domestically and internationally, paint an uncertain economic landscape.
Deutsche Bank has even suggested that historical data on the lag between economic indicators and monetary policy points towards a recession in 2024. However, some strategists maintain that if a recession does occur, it will likely be mild. Despite the rocky start, they believe that the S&P 500 can still finish 2024 on a positive note.
Ultimately, it’s important to recognize that while the Federal Reserve wields considerable influence, it is not infallible.
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