Asset Allocation
- The Inflation Battle May Not Be Over
- 2023-10-04 12:07
- Key Insights
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- U.S. inflation has declined from its June 2022 peak, leading some to speculate that the Fed could soon switch to a more accommodative monetary stance.
- We believe that an upward trend in some inflation categories, such as energy, could mean higher interest rates for longer than expected.
The U.S. Consumer Price Index (CPI) has trended steadily lower since peaking at 8.93% in June 2022. Despite higher readings in July and August 2023, core CPI—which excludes the volatile food and energy categories—has continued to decline. This has led to some speculation that the Federal Reserve could soon switch from raising interest rates to cutting them.
CPI data are reported on a year-over-year basis to help limit seasonal effects and the impact of short-term events that may prove temporary. While these readings have been encouraging, shorter‑term trends that typically offer more information about the current state of inflation are concerning. The three-month CPI moving average from July to August rose from 1.90% to 3.98% (Figure 1).
Short-Term Trends Show That Progress Has Been Moderating
(Fig. 1) Contribution to CPI* by category—three-month moving average
January 2020 through August 2023.
Past results are not a reliable indicator of future results.
Sources: Bureau of Labor Statistics/Haver Analytics. Bloomberg Finance L.P.
*Consumer Price Index (CPI) measures the monthly change in prices paid by consumers and is a widely used measure of inflation.
A moving average is a statistic that captures the average change in a data series over time.
Oil Prices Could Remain Elevated
(Fig. 2) Active U.S. Oil and Gas Rigs
September 15, 2018, through September 15, 2023.
Source: Bloomberg Finance L.P.
Notably, inflation from the shelter category, which made up 34% of the U.S. CPI basket as of August 2023, has been declining, and forward-looking indicators imply a continuing downward trend. However, other categories are facing upward pressure in the near to medium term. In particular, the energy category’s 12-month streak of negative contributions turned sharply upward in August after oil prices spiked higher.
Energy sector fundamentals point to elevated oil prices. The global supply response to higher oil prices has been modest. Meanwhile, the number of active U.S. oil and gas rigs—a useful predictor of energy supply trends—has been decreasing. Oil inventories also have been falling rapidly, and there are early indications that productivity gains in the U.S. oil patch may have peaked after increasing for more than a decade (Figure 2).
Going forward, we believe that the tug of war between easing shelter prices and rising costs in other categories, such as energy, could pressure the Fed to keep rates higher for longer than many investors expect. As a result, our Asset Allocation Committee recently added to real assets, which include a large allocation to energy-related equities, and decreased the position in long-term U.S. Treasury bonds, which could face headwinds if interest rates remained elevated for an extended period.
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Important Information
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of October 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual outcomes may differ materially from any estimates or forward-looking statements made.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks. Investments in certain industries that involve activities related to real assets may be more susceptible to adverse developments affecting those industries and may perform poorly during a downturn in any of those industries. All charts and tables are shown for illustrative purposes only.
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