The nation's top economic forecasters have sharply revised their inflation outlook upward for the second quarter, projecting that consumer prices will climb at a 6% annual rate – more than double the estimate from just three months ago.
That dramatic reassessment came as recent inflation readings reverberated through financial markets, muddying the path for the Federal Reserve's incoming leadership.
The Survey of Professional Forecasters, compiled quarterly by the Federal Reserve Bank of Philadelphia, placed second-quarter headline consumer price index inflation at 6% and headline personal consumption expenditures inflation at 4.5%, compared with prior estimates of 2.7% for both measures. The sharp upward revision came in the wake of U.S. and Israeli military strikes against Iran, which have driven energy prices higher and sent inflation data well past the Fed's 2% target.
For financial advisors navigating client conversations about purchasing power and portfolio positioning, the shift represents a meaningful change in the planning environment. InvestmentNews has been regularly checking in with advisors with respect to inflation's durability, but the magnitude of the Q2 forecast revision – moving from 2.7% to 6% in a single quarter – will likely have many standing to attention.
For the full year, the forecasters put the all-items CPI rate at 3.5%, with core inflation – which strips out twitchy food and energy components – at 2.9%. Both those figures are well above the Fed's comfort zone and up from earlier estimates of 2.6% for both. Headline PCE for the second quarter is pegged at 4.5%, with core at 3.4%.
Elevated inflation is projected to persist into the third quarter before easing somewhat by year-end, with headline CPI expected to moderate to 2.5% and core to 2.7% in the fourth quarter. Yet even the panel's long-run projection of 2.4% annual average inflation over 10 years implies a rate stubbornly above the Fed's target.
Bond markets have taken notice. Reuters and other outlets reported longer-dated Treasury yields climbing to their highest levels in a year on Friday, with the 10-year note yield rising nearly 11 basis points to 4.568% and the 30-year bond yield breaching 5.1%. The 2-year note – closely tied to rate expectations – hit its highest level since March last year.
"The bond market now is finally like, maybe this quick resolution and snap back in energy prices isn't going to happen and we've got to price in longer-term inflation expectations," Mike Sanders, head of fixed income at Madison Investments, told Reuters.
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Perhaps most striking for advisors is the pivot in market expectations for Fed policy. After years of positioning for rate cuts, investors have begun pricing in rate increases. According to CME's FedWatch tool, the probability that the Fed's benchmark interest rate will be 25 basis points higher by January's Federal Open Market Committee meeting stood at around 60% on Friday, with a December hike seen as a virtual coin toss.
The Fed, under outgoing Chair Jerome Powell, has held its policy rate in a range of 3.50% to 3.75% since December and has continued to signal a cut as its next likely move. But that language is increasingly at odds with the data.
Inflation readings at the consumer, wholesale, and import-price levels all came in ahead of already-elevated economist forecasts this week. April's headline CPI showed a 3.8% annual gain – the highest in nearly three years – while producer prices rose 6% from a year earlier, the sharpest increase since December 2022.
Retail sales data suggested consumers remain resilient in the face of higher prices, muffling the economic case for easing. "The market narrative has shifted from stagflation to reflation due to rising inflation, strong spending and booming earnings," Bank of America analysts wrote in a note to clients.
Three Fed officials dissented at April's meeting over the central bank's continued use of an easing bias in its policy statement. The minutes of that meeting, set to be unsealed Wednesday, may reveal how much broader the appetite for a more neutral or hawkish policy stance has grown within the FOMC.
The data and market repricing arrive at a delicate moment for Kevin Warsh, who was confirmed by the Senate this week and is set to assume the role of Fed chair. Warsh has publicly argued that the spread of artificial intelligence tools across the economy should lift productivity and dampen inflation pressures over time – a thesis that would support lower rates.
Read more: For Kevin Warsh, all-powerful AI equals ‘American Ingenuity’: This is what it means for advisors
He told senators at his confirmation hearing that he has made no promises to President Donald Trump, who has repeatedly and publicly pushed for lower borrowing costs, but he pledged greater cooperation between the Fed and the administration on non-monetary matters.
That framing will be difficult to sustain if inflation data continues running hot. Advisors following the Federal Reserve's rate path will be watching closely for any tells on Warsh's intent to shift the Fed's policy bias before the data compels him to do so.
The geopolitical backdrop complicates matters further. Oil prices rose roughly 2% on Friday after comments from Trump and Iranian Foreign Minister Abbas Araqchi dampened hopes of a deal to reopen the Strait of Hormuz. Trump said his patience with Iran was running thin; Araqchi said Tehran has "no trust" in Washington and would negotiate only if it saw seriousness from the U.S. side.
Forecasters in the Philadelphia Fed survey have lowered their near-term growth expectations in parallel with the inflation upgrade. GDP is projected to rise at a 2.1% annualized rate in the second quarter and 2.2% for the full year – the latter figure down 0.3 percentage point from the prior survey. Growth is seen slowing further to 1.9% in 2027, with the unemployment rate settling around 4.5% this year, 0.2 percentage point above current levels.
For advisors, the confluence of stalling growth and sticky inflation – the classic ingredients of stagflation, even if market analysts now prefer the euphemized "reflation" – argues for a reassessment of both fixed income and equity positioning. The shift from a rate-cut narrative to a potential rate-hike scenario changes the calculus on duration, on dividend-paying stocks, and on real asset exposure.
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