Diverging Inflation Experience Between the U.S. vs. EU

Dr. Jeffrey Roach | Chief Economist

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Key Takeaways

  • Markets are especially volatile as the inflation outlook remains cloudy. 
  • Rates have become choppier since Federal Reserve (Fed) Chairman Jerome Powell pushed back against market expectations of aggressive rate cuts this year. 
  • Investors with a domestic bias were rewarded as inflation in Europe was stickier, but that appears to be changing. 
  • International markets will likely react to new expectations for global central banks’ decisions. 

January Consumer Prices Surprised to the Upside 

If we’ve learned anything throughout this cycle, it’s that investors must peer beneath the headlines to get a handle on what is actually happening in the economy. Yesterday’s release on consumer prices illustrated this point.  

January’s Consumer Price Index (CPI) surprised to the upside as prices rose a bit higher than expected, disappointing markets, but investors could get solace from December’s downward revision. Consumer prices rose 0.3% in January after rising a downwardly revised 0.2% in December. Higher shelter prices contributed over two-thirds of the monthly increase, and prices also rose for car insurance and medical care. Used vehicles and clothing prices fell from a month ago. Core prices, ex shelter, rose 2.2% from a year ago, still hotter than the Fed would like. 

The bottom line is Tuesday’s inflation report wasn’t exactly what the Fed wants since services prices are still elevated and not decelerating enough to their liking. However, investors will have to wait until later this month for a more comprehensive look at consumer prices.  

Inflation in the services sector is running hotter than the pre-pandemic rate as the economy continues to hum from a strong labor market and the subsequent growth in real disposable income. It’s no wonder that services inflation has struggled to decelerate. 

Inflation On Two Different Glide Paths

Not Much Confidence for Powell

2020–2024 annual rate of inflation line graph and the two different glide paths of CPI services and durable/nondurable goods as noted in preceding paragraph.

Source: LPL Research, Bureau of Labor Statistics 02/13/24

Checking in Across the Pond

Our recent investment views included some restraint with international exposure, especially within Europe. Inflation in Europe looked worse than in the U.S. as the two regions were on different inflationary cycles. As illustrated in the chart below, U.S. inflation peaked before European counterparts and further, the peak was lower. But in recent months, things have changed. Pricing pressures in Europe have eased faster than in the U.S. and there could be important investment implications from these new developments. 

European Inflation Improving Faster than U.S.

Global Central Banks Find it Hard to be in Sync

Annual rate of inflation graph depicting U.S. inflation moving faster than European counterparts from Feb. 2020 to Nov. 2023, as noted in preceding paragraph.

Source: LPL Research, Bureau of Labor Statistics, Statistical Office of the European Communities 02/13/24

Call to Action 

LPL Research currently favors U.S. equities over their developed international counterparts. However, investors may want to consider investment opportunities outside the U.S. later this year. Portfolios benchmarked to the MSCI EAFE have 22% exposure to Japan, roughly 15% to the U.K., 12% to France, and 9% to Germany. The economic backdrop is positive for Japan as consumer demand is holding up nicely.  In Europe, if the ECB adjusts policy earlier than expected and the Fed adjusts later, investors may find a relative allocation opportunity. In markets like these, allocators often benefit with active managers able to manage variance among global markets. In short, investors should keep a watchful eye on internationals. 

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Dr. Jeffrey Roach

Jeffrey Roach guides the overall view of the economy for LPL Financial Research and has over 20 years of experience in investing and economics.