by Joe Herrle, CFA
Vice President
Alternative Assets
This week, a slew of economic reports, which included inflation data, employment figures and retail sales reports, continue to indicate that the Fed still has a way to go on its quest to tame inflation.
As a direct indication of rising prices, the U.S. Consumer Price Index (CPI) rose 6.4% year-over-year in January, exceeding forecasts. The Core CPI, or the more "sticky" inflation elements, rose 5.6% yearly. While this marks a slowdown from inflation figures seen last year, it is still going strong. Investors are confident inflation will continue its decline, as several leading indicators support this belief. Instead, it is the pace of the decline that investors are trying to divine.
More (indirect) evidence included this week’s jobless claims, which were again remarkably low at 194,000, slightly less than last week. The report comes on the back of a blowout January employment report (517,000 new jobs versus 187,000 estimated) that marks 25 consecutive months of job growth in the U.S. This week's low level of jobless claims indicates a continued tight labor market.
Echoing the unexpectedly large increase in payroll employment last month, January's retail sales and manufacturing output data were unquestionably strong, too. January retail sales surged +3.0% from the month prior, indicating continued U.S. economic momentum.
2023 began with a burst of momentum, including stubbornly higher prices, a robust labor market and strong consumers. We are led to a single conclusion: the Fed may need to pursue a higher-for-longer rate policy. So far, markets believe this may be the case, too, as we now see the market pricing in three more 0.25% rate hikes. Perhaps more notable is that the expectations for cuts are beginning to be priced out.
Bond yields have increased as the market factors in the prospect of higher rates, making them more attractive. Ultra-short duration Treasuries and money market funds have seen yields rise to levels not seen since August 2007. And the increase has been quick; yields on U.S. 3-month Treasury Bills going from almost zero in 2021 to 4.79% this month.
In the long run, we believe investors are better served staying in stocks and bonds than cash. Coupled with higher inflation, an additional cost of holding cash comes in the form of reduced purchasing power. If one must hold cash, one would likely be better served in a money market fund that currently earns 4% on an annualized basis. In our opinion, the opportunity costs of not staying invested are just too high.
Takeaways for the Week
Inflation remains slightly more elevated than expected, causing bond yields to rise as the Fed may need to hold rates higher for longer
The economy remains stable in the early innings of 2023 despite tightening financial conditions
Holding cash in today’s environment has significant opportunity costs, with high inflation eating away at purchasing power