Trump Trade Muddles Inflation Outlook in Fed’s Favorite Gauge

The recent surge in the stock market following President-elect Donald Trump’s victory is expected to impact the Federal Reserve’s preferred inflation gauge, potentially influencing interest rates. This post-election rally has led to an increase in the cost of portfolio management and investment advice services, a category within the personal consumption expenditures price index that closely follows market movements. Changes in this category play a vital role in shaping Fed policy decisions by contributing to a key metric of broader services inflation that policymakers closely monitor.

According to Skanda Amarnath, Executive Director of Employ America, stock market effects contribute to more than a third of excess core services inflation compared to pre-pandemic trends. If stock prices continue to rise sharply, the Fed may need to adjust its approach, possibly adopting a more hawkish stance or slowing down rate cuts. A correction in the equity market could simplify matters for the central bank.

The S&P 500 surged before and after the presidential election as investors bet on Trump’s victory and expected pro-business policies under his administration. Notably, the portfolio management category within the PCE price index is anticipated to show an increase in data due Wednesday, aligning with producer prices that saw a 3.6% rise in October. This category, introduced in the early 2000s, reflects changes in revenue for mutual fund and asset managers providing investment advice, with trends mirroring movements in the equity market with a slight lag.

While the portfolio management category makes up around 1.5% of the overall PCE basket, it can have a significant impact during market volatility. Economists predict this stock-market momentum to persist, potentially fueling inflation amidst expectations of favorable business conditions under the incoming Trump administration.

Federal Reserve officials have signaled a cautious approach to further rate cuts, citing a strong labor market and robust economic growth. Despite potential concerns about inflation stemming from stock market gains, policymakers are likely to remain watchful and interpret recent volatility with prudence, recognizing the transient nature of market-driven inflation.

Amid uncertainties surrounding the economic outlook, including the potential impact of Trump’s policies, Fed officials are expected to maintain a balanced stance. While stock market gains may contribute to inflation, policymakers are likely to view this as a temporary factor that could revert in due course.