Economists: Inflation slowdown signals Goldilocks scenario

Some investors believe that the slowdown in inflation in the U.S. last month may signal the start of a Goldilocks scenario, wherein the central bank can bring down prices without significantly damaging the economy.

The consumer price index unexpectedly fell in February for the first time in over two years. Despite the positive effects of other economic indicators, including employment, inflation remained subdued.

Ipek Ozkardeskaya, an analyst at Swissquote Bank, said that the strong job market and the soft inflation data support the idea of a Goldilocks scenario.

The drop in inflation could boost the case for the Fed to reduce its rate hikes earlier than expected. It could also help avoid a recession, which many experts had feared would happen after last year's stock market decline.

Despite the soft inflation data, the Fed has yet to indicate that it plans to deviate from its previous projections. It still expected its key policy rate to reach between five and 5.25 percent this year.

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The market's pricing indicates that investors are still firmly focused on a more dovish stance regarding the Fed's policy rate. The key rate had peaked below five percent in June before declining in the second half.

Subdued inflation

Inflation data released on Thursday reinforced the belief that the Fed would reduce its rate increases in the coming months. The odds of the central bank raising its key policy rate by 25 basis points have increased from around 75 to around 90 percent.

"The report confirms that inflation is in a downward trend and that it has reversed," said Peter Cardillo, an economist at Spartan Capital. "In other words, it has peaked, and seems to be in a downward trend. That's a positive going forward. If this continues, we can expect a less aggressive Fed which is good news."

Rick Rieder, a chief investment officer at Blackrock, said that the Fed's aggressive rate increases were over. He also added that the Fed is expected to raise its key policy rate by 25 basis points at its next two meetings.

The market's moves were more subdued than in the previous volatile months when consumer price data came along with significant swings. Major stock indexes were up slightly on Thursday, while the 10-year Treasury yield was down around 11 basis points.

According to data from Optiver, the short-term options market had priced in a significant move before the release of the consumer price data. Several days before the release, the S&P 500 had moved in either direction on an average of almost three percent, more than twice its usual swing of 1.2 percent.

The stock market's relatively subdued reaction to the soft inflation data was also attributed to the fact that the index has gained around three percent so far this month.

"It was a bullish story, but we had traded up into it anticipating it ... and that compressed the actual post-event trade," Economist Charlie McElligott said. "There have been a number of discretionary, macro, tactical folks who had this disinflation Goldilocks kind of risk trade on to start the year."

According to Tiffany Wilding, an economist at PIMCO, the Fed is most likely to raise its rates twice this year before stopping. She noted that the Fed still needed to maintain a cautious stance regarding the implementation of its monetary policy. However, Wilding also said that the recent improvement in inflation would lead to a reduction in the need for further rate increases.