What’s Not Baked In?

December 16, 2024

This week should bring another interest rate cut by the Federal Reserve, as the futures markets are indicating. ¹

Yet headline inflation has ticked up a bit after several months of moderation. ²

The recent CPI data suggests inflation is stalling above the Fed’s 2% target and might influence interest rate policy in the coming months. Housing costs, particularly rent and shelter components, continue to be persistent inflationary factors that have proven difficult to combat. (OER is owners’ equivalent rent). ³

When looking at the U.S. macroeconomic picture, it’s starting to look like growth will continue, presenting another challenge to the Fed’s lower interest rate mantra. GDP in Q4 is expected to grow at around 3.3% on an annual basis. ⁴

The strength of the consumer is driving more growth as well as sticky inflation. It’s also driving strong corporate earnings growth for Q3 and expectations for Q4. ⁵

So, what’s not baked into investors’ expectations? Reflation.

Even if you strip out the sticky housing component, the trend (Supercore inflation) is looking challenging for the Fed. ²

Two things are going to occur this week:

First, the Fed will likely implement another 25 basis point interest rate reduction while adjusting their language to reflect reinflationary concerns.

The other event this week will be the release of the Fed’s favored inflationary readings, announced on Friday. That will either confirm or debunk the reinflationary threat.

We should be willing to live with a higher interest rate picture from the Fed in the coming months. While this scenario isn’t currently baked into investors’ expectations, it should be. ⁶

That might provide for a normal correction or pullback for the S&P 500. Corrections and pullbacks are a normal part of investing – or at least they used to be. ⁷

These changes are a normal part of the investment cycle and should be baked into our expectations for the short run.

If you have questions or comments, please let us know. You can contact us via X and Facebook, or you can e-mail Tim directly. For additional information, please visit our website.

Tim Phillips, CEO, Phillips & Company

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