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Sticky Inflation Complicates Fed's Rate Cut Plans

Wall Street's interest rate predictions fell flat.

That was a nasty inflation surprise

Fading optimism as inflation proves sticky.

The Federal Reserve has had a difficult time bringing inflation down to its target. The data is further proof of that. According to data released last week by the Bureau of Labor Statistics, consumer prices increased by 3.5% year over year in March.  The Fed may delay cuts to interest rates due to the news. The Federal Reserve wants inflation to decline toward 2% annually.

Disinflation optimism fades: in 2023's smooth decline in inflation may not continue; 2024 brings persistent price increases. The optimism surrounding the steady decrease in inflation rates observed throughout 2023 appears to be waning in 2024.

Inflation proves sticky: Recent inflation data consistently outpaces forecasts, suggesting a more entrenched problem. The latest data on inflation have consistently exceeded economic forecasts, indicating that the issue of high inflation is becoming more deeply rooted than previously thought. This persistent inflation, or "sticky inflation," suggests that reducing inflation could be more complex and prolonged, requiring possibly more restrictive monetary policy.

Fed faces a dilemma: Balancing the need to cool inflation against the desire to support a growing economy creates uncertainty around cutting interest rates. The Federal Reserve is currently facing a complex challenge, which creates a significant degree of uncertainty regarding future monetary policy, particularly decisions around rate cuts.

Investors adjust expectations: Markets have dramatically scaled back predictions of rate cuts this year. Financial markets and investors have significantly revised their expectations. Given the ongoing economic conditions and inflation concerns, expectations have been sharply reduced, reflecting a more cautious outlook on the part of investors.

Jerome Powell was right: The Fed Chairman's cautious approach and emphasis on data dependence now seem wise.

Market vs. Fed: Investors initially expected more rate cuts than the Fed; now the Fed's projections appear less aggressive. As conditions have evolved, the Fed's more conservative approach now seems to align more closely with economic realities.

Beyond CPI: The Fed will monitor additional metrics like PCE and wage growth before adjusting policy.

Inflation denialism echoes: Dismissing current price increases as temporary is reminiscent of 2021's mistakes.

The bottom line: Robust growth is colliding with supply constraints, fueling sticky inflation and making looser monetary policy unlikely.

The Data - inflation uptick

What is happening with inflation?

The March 2024 Consumer Price Index (CPI) report highlights a 0.4% month-over-month increase, mirroring the previous month's rise, with an annual (year-on-year) increase of 3.5%. Key drivers of this inflation include rising costs in shelter and gasoline.

  • Shelter: The shelter index continued to rise, with significant increases noted in rent and owners' equivalent rent of residences.

  • Motor Vehicle Insurance: This index rose significantly, reflecting broader trends in the transportation sector.

  • Medical Care: Medical care costs also showed an upward trend, particularly in hospital services.

With respect to housing, I believe housing inflation will remain elevated for the foreseeable future until new supply is brought to market. There are two ways of bringing new supply to market: (a) new construction (b) sale of existing homes.

New construction will increase over time. Existing home supply is a bit more nuanced to understand. Let’s assume you purchased a single family home with a 30-year mortgage at 2.75%. Nobody in their right mind will give up their 30-year mortgage at 2.75% for one at 7%. It just isn’t going to work. Therefore, the only substantial new supply is going to come from new construction and that will ultimately benefit the large publicly traded homebuilders.

Financial Planning Reminders

Below are some topics to discuss with your financial advisor before the summer.

Investment Review: Reviewing your investment portfolio performance, discussing any needed rebalancing, and considering any strategic changes based on market conditions or economic forecasts.

Retirement Planning: Assessing whether you are on track with their retirement savings goals and making any necessary adjustments to contributions or investment strategies.

Budgeting and Cash Flow Planning: We are done with Q1 2024. It is time you reviewed your budget and cash flows, setting goals for the remainder of the year, and planning for any significant expected expenses.

Bonuses and Compensation: Discussing how to best allocate any bonuses that were paid out Q1 2024, whether to invest, pay down debt, or save for future expenditures.

Required Minimum Distributions (RMDs): If applicable, making sure that anyone over age 72 take their RMDs from retirement accounts to avoid penalties.

Roth Conversions: How do I tax optimize my retirement distributions? Should I convert part of my IRA into a Roth IRA? (e.g. IRA, 401k, taxable brokerage, Roth IRA, etc.)

Gifting Strategies: Discussing any plans for gifting to family members or charities, including the use of annual gift tax exclusions.

Regulatory or Legislative Changes: Informing you about any recent or upcoming regulatory or legislative changes that could affect your financial planning.

Below are some topics to review if there was a life change

Estate Planning Updates: Reviewing and updating estate planning documents, such as wills, trusts, healthcare directives, and powers of attorney, if necessary.

Insurance Review: Evaluating current insurance coverage, including life, disability, long-term care, and property and casualty insurance, to ensure adequate protection.

Educational Planning: For someone with children or grandchildren, discussing savings strategies for education expenses, such as 529 plans.

Beneficiary Designations: Ensuring that all accounts with beneficiary designations (like IRAs, 401(k)s, and insurance policies) are up to date.

Operations Update

As part of my effort to keep you up to date about my business, I want to let you know about a couple of updates.

Over the past two years, internal operating costs have increased substantially. One significant factor is the rise in software subscriptions.

Some providers, like Ycharts, have increased their prices significantly, which is why I've opted not to renew our subscription with them. I've found a good replacement called Koyfin.

I recently subscribed to Holistiplan, which automates a portion of the tax planning process by helping me review tax returns and generate actionable planning points swiftly.

Thank You

As we close this edition, let's remember that financial well-being is not just about the numbers on a spreadsheet or the balance in an account. It's about the peace of mind that comes from knowing you're on the right path, the confidence to face life's uncertainties, and the freedom to pursue your passions.

In the ever-evolving landscape of finance, our commitment remains steadfast: to empower and guide you towards a brighter financial future. Until next time, stay informed, stay proactive, and most importantly, stay inspired.

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