5 reasons why inflation will be stickier than expected going forward, Deutsche Bank says

It’s tempting to think the Federal Reserve’s fight against inflation is over, given the central bank’s recent rate cuts and sharpened focus on the labor market. But it’s not yet time for investors to relax, Deutsche Bank wrote on Monday.

Though inflation now hovers close to the Federal Reserve’s 2% target rate, it’s not yet time to declare victory: prices continue to run hotter than expected, and that’s happening alongside monetary easing.

“If inflation does return, this could have very important implications for markets,” Deutsche Bank strategists said. “We saw in 2022 how there was a massive selloff across both bonds and equities.”

The firm detailed five reasons why inflation risks must still be monitored:

First, initial interest-rate cuts have been more broader and deeper than expected on a global basis. In the US, the Federal Reserve cut the Fed funds rate by 50 basis points, citing lower headline inflation to justify its aggressive policy flip.

While that much is true, history shows that easing cycles are precisely the time to be cautious over inflation, Deutsche said.

“If inflation does prove sticky above target today, then that could force central banks to keep monetary policy in restrictive territory for longer,” the note said.

Second, stimulus momentum in China and worsening geopolitics in the Middle East have triggered a notable pickup in commodity prices.

Oil prices have jumped this month as investors adjust to escalating tensions between Israel and Iran. After an Iranian missile attack on Israel triggered promises of retaliation, the market has braced for a possible disruption to the region’s crude output.

Brent crude gained sharply in early October, peaking at $80 per barrel. Deutsche noted this as a considerable high, noting that the international benchmark traded below $70 a barrel just one month prior.

If Israel’s response decimated Iran’s oil installations, analysts expect prices to hit as much as $200 per barrel.

Meanwhile, industrial metals such as copper have also taken flight, after China announced a series of stimulus measures to reenergize its fleeting economy. The metal is a key component in construction and manufacturing, and can stand to benefit if the world’s second-largest economy recovers.

Third, odds of a US recession are ebbing as the economy shows signs of resilience that could keep inflation elevated.

“Much as the stronger news on growth is welcome, it also means that economic demand and inflation is likely to be stronger than it would otherwise have been,” analysts wrote.

Fourth, September’s consumer price index report surprised investors last week.

Not only was the inflation reading higher than estimated, core CPI ran at its fastest pace in six months, gaining 0.31%. Core CPI’s three-month annualized rate moved up to 3.1%, compared to August’s 2.1% print.

“Although that’s only one report, it served as a reminder of how inflation could prove more persistent, and it were the stickier categories in the basket that were holding inflation up,” Deutsche wrote. For instance, the Atlanta Fed’s “sticky CPI” measure stood at its strongest in five months.

Fifth, money supply growth is still accelerating.

According to the bank, an increase in this measure can be read as an advance warning that inflation could stay persistently high. This was the case in the post-pandemic period, Deutsche said — though it is admittedly moving up from a low base.

The firm cited the fact that in August, US M2 money supply rose 2.0% year-over-year, the highest growth rate since September 2022.