Is U.S. Inflation "Rising Again"? Pay Attention to These Four Signals!

According to analysis from Charles Schwab, the Federal Reserve's mission to reduce inflation to 2% may soon face obstacles. The company points out that investors should pay attention to four key signals to determine whether prices may accelerate again.

Although overall inflation in the United States is cooling, Schwab's strategists expect inflation to gradually decline along a "twisted" path. In their latest research report, they mention that some pressures in the economy could reverse the trend of slowing inflation and even push prices up again.

“We believe inflation will continue to decline, but potential risks include Federal Reserve rate cuts, stronger-than-expected economic growth, and policy proposals from President Trump,” the strategists wrote, specifically mentioning factors such as Trump's plans to impose tariffs on U.S. imports, tax cuts, and potential reductions in labor supply through immigration restrictions.

“Tariffs often lead to one-time price increases, as the costs for importing companies are typically passed on to consumers. Similarly, tax cuts may provide more stimulus to an already healthy growing economy. Immigration reform could lead to higher labor costs.”

Trump has rebutted claims that his economic plans would trigger inflation, stating that he would lower prices in the U.S. during his second term. During his first term, when he implemented tariff policies, there was no significant surge in inflation, but experts believe that the scope of tariffs Trump plans to implement this time is broader, leading to different inflation forecasts.

Meanwhile, the Federal Reserve may have already encountered resistance in lowering inflation to 2%, as Powell mentioned last week, there may be some bumps along the way in the process of inflation retreating. According to data from the U.S. Bureau of Labor Statistics, the October CPI rose 2.6% year-on-year, in line with economists' expectations but higher than last month's 2.4%. Therefore, Schwab states,

“Looking ahead, it is worthwhile to assess the potential risks facing the slowdown in inflation.”

The strategists proposed the following four market signals to determine whether inflationary pressures in the economy are intensifying:

Rising Labor Costs

Recently, labor costs have accelerated, with unit labor costs for all workers in the business sector rising 3.4% year-on-year in the third quarter, which is considered inflationary because wage increases raise business costs, potentially prompting companies to raise prices, thus forming a "wage-price spiral." Schwab's strategists stated:

“While it is still uncertain whether this upward trend will continue, if labor supply is constrained and wages rise, faster growth in unit labor costs could further boost inflation momentum.”

Unit labor costs rose 3.4% year-on-year in the third quarter.

Reversal of Stock-Bond Correlation

Generally, stock prices and bond yields have an inverse relationship. When the market expects interest rates to rise, this expectation is reflected in the bond market, leading to higher bond yields. Higher interest rate expectations are unfavorable for stock prices, as rising rates negatively impact corporate profits and investment sentiment However, the 120-day rolling correlation between the S&P 500 index and the 10-year U.S. Treasury yield has turned positive, indicating that due to strong economic growth expectations, both stocks and yields are rising simultaneously. Strategists wrote:

"If this correlation turns negative again, it may indicate that inflation (once again) becomes the main source of downside risk for stocks."

The S&P 500 index shows a positive correlation with the 10-year U.S. Treasury yield.

Rising U.S. Treasury Yields

Since Trump's successful re-election, the 10-year U.S. Treasury yield has continued to rise, breaking through 4.4% the day after the election, reaching its highest level since early July. This reflects market concerns about higher interest rate expectations and also shows investors' worries about future inflationary pressures.

"Worries about a potential rebound in inflation stem from strong economic growth since September and potential expansionary fiscal policies. These factors are leading the market to reduce expectations for further rate cuts by the Federal Reserve," noted Charles Schwab strategists.

Strengthening Economic Momentum

Current U.S. economic growth appears to be stronger than investors' expectations, which is also one of the factors that could drive inflation. The Citi Economic Surprise Index has risen significantly in recent months, climbing from -50 in the summer to 40 in November.

Charles Schwab expects that if inflation continues to decline, the Federal Reserve will continue to cut rates in the coming months. However, compared to a month ago, they hold a more cautious view on the pace and magnitude of rate cuts in 2025. Strategists added,

"Stronger economic growth means that the Federal Reserve may not cut rates as significantly as previously expected a few months ago. Additionally, considering that the new government's policies may bring higher inflation, expectations for the Fed's rate cut path are changing."

As investors digest the implications of Trump's victory, according to data from the CME FedWatch tool on November 18, the probability of the Federal Reserve maintaining the current interest rate in December is 38.1%, opening a new chapter for the economic narrative