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Trump Trade Muddles Inflation Outlook in Fed’s Favorite Gauge
(Bloomberg) -- A stock-market rally boosted by President-elect Donald Trump’s victory is set to put upward pressure on the Federal Reserve’s preferred inflation gauge, which in turn could keep interest rates elevated.
The post-election surge in stock prices will register as an increase in the cost of portfolio management and investment advice services, a category within the personal consumption expenditures price index that largely follows swings in the market. Moves within that category have a direct impact on Fed policy decisions as they feed into a key metric of broader services inflation that officials watch closely.
Services inflation has been a relatively stubborn component of the overall PCE index, which is seen rising 0.2% in October from the prior month and 2.3% from a year ago in data due Wednesday. Skanda Amarnath, executive director of Employ America, estimates stock-market effects account for more than a third of excess core services inflation compared with the pre-pandemic trend.
“Either stocks have to correct or the Fed’s going to be in a position where they’re forced to slow down their cuts and be a little hawkish,” Amarnath said. “If the equity market corrects more sharply this month, then a lot of things get a lot easier.”
The S&P 500 climbed ahead of the Nov. 5 presidential election on bets Trump would win and reached a record high after he did, as investors piled into the so-called Trump trade — betting the president-elect will enact pro-business policies once he returns to the White House in January.
Economists have a pretty good idea of what the portfolio management category will show in Wednesday’s data. That’s because PCE uses similar source data as another monthly government report on producer prices, which showed portfolio management fees advanced 3.6% from the prior month in October, the most in six months.
The component was introduced in the government’s price analysis in the early 2000s. It is based on changes in the amount of revenue mutual fund and asset managers receive for providing investment advice. The category tends to track the equity market reliably — with a roughly one-month lag — because better-performing stocks mean higher fees for asset managers.
The PCE equivalent accounts for roughly 1.5% of the overall basket — not a lot, but enough to move the needle when markets see significant swings.
The stock-market momentum “is likely to remain a persistent source of inflation amid expectations of easier business conditions next year under the Trump administration,” Bloomberg economists Eliza Winger and Estelle Ou wrote in a note last week.
Fed officials have indicated they’re in no rush to keep cutting rates as long the labor market remains resilient and the economy continues to power ahead.
And while Trump’s agenda may be good for business, concerns around whether it could rekindle inflation may become another reason for restraint.
As for the risk that stock-market gains may continue to boost inflation, policymakers will likely know to look through the recent volatility, said Veronica Clark, an economist at Citigroup Inc.
“It’s not necessarily something you ignore,” said Clark. “But strength from that component isn’t really something that would be so concerning to Fed officials — partly because it’s so volatile, so it would revert at some point.”
--With assistance from Molly Smith.