Weekly Investment Update (02/14/2025)

Stocks were range-bound again this week amid a flurry of inflation- and trade-related headlines. Although CPI came in higher than expected, PPI included more encouraging details that led investors to reprice the magnitude and timing of Fed rate cuts in a somewhat dovish direction. Inflation data this week does not change our view that price pressures will continue to ease throughout the year, giving the Fed more flexibility to act than the market currently believes.

Related to trade, Trump outlined a plan for reciprocal tariffs to “level the playing field.” However, the plan lacked detail and signaled no immediate action, leaving room for further negotiations.

Financial markets have remained resilient as investors attempt to handicap various outcomes. Interestingly, even immediately after the hotter-than-expected CPI report, credit spreads tightened, the dollar eased, and cyclical areas of equity (consumer discretionary) outperformed more defensive sectors (consumer staples). Softer retail sales on Friday, although not concerning to us given upward revisions to prior months, provided additional rate relief as the 10-year Treasury yield fell to 4.47%.

Although CPI Was Above Consensus, Disinflationary Trends Remain Intact

What is happening: The January CPI report was higher than consensus expectations, with the headline figure rising to 3.0% year-over-year, and the core rate increasing to 3.3% year-over-year. While January’s report showed a modest uptick in inflation, the release included revisions to seasonally adjusted data from 2017 to 2024. The complicated seasonal adjustment process often inadequately accounts for firms’ price resets at the start of the year, which can lead to higher-than-expected inflation prints in the early months of the year. Because of this, surprises to CPI over the last 25 years have been more likely to be biased to the upside in the first half of the year than in the second half.

Outside of seasonal factors, many of the historically volatile inflation categories also contributed to January’s increase. Food at home, or grocery prices, rose 0.5% on the month, with egg prices rising a staggering 15.2% in January due to a nationwide egg shortage caused by the spread of Avian flu. At the same time, core services inflation accelerated more than expected, primarily because of increases in transportation and shelter prices. Much of the increase in the transportation services category was in motor vehicle insurance, rising 2.0% on the month, driven by the lagged impacts of higher vehicle prices. Rental prices remain a source of upward price pressure, though shelter inflation was also higher alongside a jump in hotel prices. However, real-time data on rents continues to suggest shelter prices should moderate going forward.

Why it matters: The Fed is likely to look through any short-term data distortions, but the stronger-than-expected inflation report may, at the margin, influence the Fed to remain on hold for now. Fed Chairman Powell has reiterated that the economy is solid, with a labor market “broadly in balance,” but he also cautioned against overinterpreting one or two inflation readings. It is also important to note that, while CPI is a relevant inflation metric, PCE is the Fed’s preferred measure of inflation. Notably, motor vehicle insurance, an area that saw price pressure in the recent CPI report, is not a component of PCE. Additionally, components of the January PPI report that feed directly into PCE came in softer, specifically within categories such as airlines and medical services.

We continue to expect gradual progress on inflation as lagging indicators catch up with real-time data. That said, if progress is slower than expected, further rate cuts may be delayed toward the second half of the year. As the labor market remains robust, the Fed is likely looking for additional clarity on fiscal policy as well as further progress on its 2% inflation target in order to resume cutting rates. While the market is currently pricing in only one Fed rate cut in October, we believe the market may be over indexing to recent data and we could see more rate cuts this year than currently priced in.

Powell Reinforced Expectations That the Fed Will Be on Hold for a While

What is happening: This week, Federal Reserve Chairman Jerome Powell spoke at the semiannual congressional hearing. Powell emphasized that current monetary policy is significantly less restrictive than it was earlier last year and that the Fed is not in a hurry to lower interest rates further. At the same time, the Fed chair left open the possibility of cutting rates faster than planned if the labor market weakens more than expected or inflation decelerates sharply. Powell was noncommittal when answering questions related to the recent tariff announcements and stressed the need to wait for more clarity around the magnitude and length of the tariffs that will actually be implemented. Regarding the Fed balance sheet, Powell said current reserves are meaningfully above adequate levels while also acknowledging the difficulty of gauging exactly how many reserves are needed.

Powell’s testimony on Tuesday and Wednesday followed Scott Bessent’s TV interviews from last week, where the Treasury secretary clarified that the Trump administration is not calling for the Fed to lower the fed funds rate. Bessent emphasized the administration’s focus on lowering longer-term rates such as the 10-year Treasury yield and confirmed plans to maintain the current size of Treasury bond auctions for the next several quarters.

Why it matters: Overall, Powell’s comments were consistent with our expectations that the Fed will leave interest rates unchanged at the next FOMC meeting. We also believe the Fed will continue its balance sheet runoff plan for at least several more quarters as it further reduces its $6.8 trillion of assets.

Bessent’s comments eased concerns about Fed independence given President Trump’s interest in influencing short-term interest rates. Market participants have been worried that the administration could pressure the Fed to lower rates prematurely and cause inflation to rebound. In addition, the Treasury’s decision to hold auction forward guidance unchanged is favorable for bonds in the near term. All else equal, an increase in bond issuance would put upward pressure on yields. However, it’s important to remember that the situation remains fluid, and the current administration has been known for making swift policy shifts.

Bessemer’s fixed income portfolios maintain their longer-than-benchmark duration positioning as we believe interest rates continue to be biased toward the downside. With markets now pricing in only one federal funds rate cut for 2025, we believe there is a higher likelihood for more cuts to actually occur than fewer cuts. At the beginning of this year, we had already anticipated U.S. GDP growth to slow toward long-term averages of 2%. The recent tariff announcements in combination with restrictive policy rates have the potential to push economic activity even lower. While tariffs have a one-time inflationary impact, they can also have a long-term dampening effect on global economic growth if they remain in place for a prolonged period of time. In our view, the Fed is likely to react aggressively if U.S. economic growth slows below trend later this year.