The PCE inflation data that came out on Friday shows that the Fed’s preferred measure of inflation, namely core inflation excluding housing, also known as supercore inflation, increased in January to 4.6%, dramatically above the Fed’s 2% inflation target. The economy outside the interest rate-sensitive components – which only make up 20% of GDP – is simply not slowing down.
Even the housing market is starting to show signs of a rebound, driven by strong job growth, high wage growth, and high levels of savings across the income distribution, which is particularly problematic given the consensus expectation that OER should be declining over the coming quarters. As a result, the Fed has to raise interest rates more, and this continues to be a downside risk to equity and credit markets.
A Fed-driven tightening in financial conditions with higher rates, lower equities, and wider credit spreads increases the probability that no landing will be followed by a hard landing.
Source: BEA, Haver Analytics, Apollo Chief Economist
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