Vanguard Sees Calm Amid Inflation Shock

Inflation figures for October exceeded forecasts, with consumer prices rising 0.4% and core prices climbing 0.3%. Vanguard economists attribute these increases largely to the lingering effects of tariffs and elevated energy prices. They argue that excluding these supply-side factors, underlying inflation is significantly closer to the Federal Reserve's 2% objective.

Vanguard has identified three main shocks contributing to inflation: tariffs, energy prices, and demand related to the AI buildout, the latter of which is increasing electricity costs. The firm anticipates that the price impacts from tariffs, enacted earlier, will begin to drop out of year-over-year calculations by early 2025, potentially reducing core PCE inflation to 2.5% by April 2027.

While energy prices represent a more persistent challenge, Vanguard predicts that their contribution to inflation should remain limited unless prices experience a sustained increase. Despite the nuanced view on inflation's composition, Vanguard still projects one additional Federal Reserve rate hike by early 2027, raising their year-end 2026 core inflation forecast to 3.2% in response to energy costs affecting core prices.

This projected Fed action contrasts with some Federal Reserve officials who are leaning towards a December hike, with some advocating for a larger increase if inflation data remains high. Traders are currently pricing in a quarter-point hike at the upcoming meeting. Vanguard suggests that modest policy adjustments can maintain price stability while balancing the job market, a balance crucial for consumer borrowing costs like mortgages and credit cards.