The Consumer Price Index (CPI) report released the week before Donald Trump’s inauguration as the US’s 47th president would have been welcomed and dreaded by his administration.
The report provided some comforting signals, including a decline in core inflation to 3.2% from 3.3% in the previous three months. Core inflation represents underlying price pressures on goods such as cars and services such as hospitality. This unexpected drop led to an immediate rally following a fortnight of market nervousness and short positions.
But there were also signs of simmering inflationary pressures on some parts of the economy. Headline inflation (core inflation plus food and energy prices) rose to 2.9% in December from 2.7% in November. Inflation increases at the end of the year and in the first quarter are not uncommon. As shown in Chart 1, inflation tends to trend upwards during this period due to annual price resettings and cold weather demand pushing up energy prices.
Inflation could be sticky under Trump
However, seasonal effects are less of a concern this year and the biggest risk to inflation is policy. President Trump’s threats of reduced immigration and higher trade tariffs, if fully implemented, could bring inflationary pressures back into the US economy.
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These fears were voiced by the US Federal Reserves in its December meeting. The minutes, which were published earlier this month, noted that there was now “elevated uncertainty” about the effects of potential policies, which meant that “it could take longer than previously anticipated” to reach the Fed’s inflation target of 2.0%. As a result, the Fed concluded that the pace of interest rate cuts could slow to just two cuts in 2025.
The details of the CPI report are also worrying for Trump. Amid highly publicised campaign promises to bring down the cost of everyday goods and services, the report highlights that the price of groceries, fuel and rents trended up in December. In a recent interview, Trump suggested it would be “hard” to bring prices down.
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Impact on Asia
Trump’s policies could raise inflationary pressures in the US and other parts of the world. Over in Asia, such warnings have caused Asian currencies to weaken further against the USD. The USDCNY reached 7.33 following the Fed’s meeting minutes, a new 17-year high. There are now concerns that if this USD strength continues, Asian economies face the potential for imported inflation. While a lower currency makes exports cheaper, which could help to offset US tariffs partially, it can also make imports more expensive and, therefore, push up inflation. Higher inflation makes it more difficult for Asian central banks to spur growth by further cutting rates.
Reasons not to overreact
A growing number of economists are raising the possibility of a “second wave of inflation” similar to that seen in the 1910s, 1940s and 1970s. For example, US inflation spiked to 11% in 1974 and eased for two years before reaching a new peak at the end of the decade.
However, we think such fears are excessive. These were periods dominated by global wars and energy supply disruption, resulting in significant cost-push inflation. In contrast, before Trump’s election, even traditionally sticky components of US inflation, such as services, rentals, auto insurance, etc, looked to be easing. As such, even an aggressive implementation of Trump’s immigration and tariff threats is unlikely to cause US inflation to cross 3.5%.
In our view, Trump’s bark is worse than his bite, given that he has used such threats more as negotiating tactics in the past. Also, as mentioned, inflation is a central tenet of his election campaign, and the impact his policies have on prices will be closely monitored.
Reasons not to under-react
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That said, investors should not be complacent about inflationary pressures either. We retain our long-held view that global inflation will be higher for longer, and our base case is for core US inflation to range between 2.5% and 3.0% for an extended period. This reflects our expectation that Trump’s policies will put upward pressure on the prices of goods but that disinflation could continue in other areas of the economy, such as services.
In terms of timeframes, we expect core Personal Consumption Expenditures (PCE) to end 2024 at around 2.8% before falling closer to 2.5% in the first half of 2025 and rising thereafter towards 3.0%. These numbers are consistent with our target of one to two Fed rate cuts in 2025.
This calls for individuals and institutions to consider the potential return on their investments and potential real returns, net of inflation. Assuming 2025 inflation persists above the central bank’s 2.0% target, bank deposits and certain ultra-low-risk investment returns may not be enough to hedge against price rises or ensure steady earnings growth.
Additionally, dollar strength and US tariff uncertainties could cause Asian equities to underperform in the short term. Given this, investors may want to tilt towards Asian fixed income in the first half of the year. Investors can consider buying Asian equities on significant dips, especially as the tariff overhangs fade.
Chong Jiun Yeh is the chief investment officer of UOB Asset Management
