Strategist Henry Allen noted a growing gap between market expectations for limited tightening by the Fed and ECB and the actual acceleration of prices. He cited the US ISM services index, which indicates that input costs are rising at levels similar to the post-pandemic period when US CPI inflation was approximately 5%.
Factors contributing to price increases include the ongoing Middle East conflict, disrupted supply routes, and extreme weather affecting agricultural production. These pressures are driving up the costs of energy, food, and metals.
Despite warnings from Fed Chair Kevin Warsh that inflation is not slowing meaningfully, markets are currently pricing in only two Fed rate hikes by the end of July 2027. ECB markets are pricing in roughly three quarter-point increases by July.
Allen emphasized that investors have underestimated the central banks' willingness to engage in aggressive rate hikes in four of the last five years. He warned that if these pressures continue, equity and credit markets may be forced to adjust.
