More (Im)patience

The Federal Reserve (Fed) has promised patience, but financial markets now want more.

On Wednesday, Fed members unanimously voted to keep rates unchanged, and Fed Chair Jerome Powell repeated several times in his May 1 post-meeting press conference that further patience is appropriate. That patience, which soothed stocks earlier this year, spurred nearly a 1% intraday selloff in the S&P 500 Index.

Investors have pointed to slowing consumer inflation as a case for lower rates, and bond markets have increasingly positioned for a rate cut. As shown in the LPL Chart of the Day, growth in core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, has slowed in the first three months of this year, falling as the global economy has struggled with trade uncertainty.

Consumer Inflation Trailing Away from Federal reserve Target

While the pace of core PCE growth isn’t alarmingly slow, the downward trend over the past three months runs counter to the Fed’s intentions.

Still, Powell attributed lower inflation to transitory factors. He also correctly noted that core PCE growth stayed close to 2% for much of 2018, so fundamentals before the first quarter volatility supported the Fed’s inflation target. Producer prices and wages have steadily risen over the past few months, and we expect businesses to eventually adjust their prices accordingly as demand picks up.

“We think the trend of slowing consumer price growth is temporary and that inflation could pop higher as pricing pressures build,” said LPL Research Chief Investment Strategist John Lynch. “If consumer price growth picks up, we think there is a better chance of a rate hike later this year, rather than a cut.”

Other parts of the U.S. economy are rebounding, so we don’t see a strong argument for a rate cut right now. At the very least, Powell made it clear that the Fed doesn’t have enough clarity to move policy in either direction, which is prudent given the persistent mixed signals in some data series. For now, the Fed remains in wait-and-see mode as trends settle and growth stabilizes.

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