Don't take it lightly! Deutsche Bank warns that future inflation will be more difficult

Since the Federal Reserve recently cut interest rates and paid more attention to the labor market, it is easy to assume that the Fed's fight against inflation is over. However, Deutsche Bank indicated on Monday that now is not the time for investors to relax.

Although inflation is now hovering around the Fed's 2% target interest rate, victory cannot be declared yet: inflation continues to be hotter than expected, and this happened when the Federal Reserve initiated monetary easing.

“If inflation does make a comeback, it will have a very important impact on the market,” Deutsche Bank strategist said. “We saw massive sell-offs in both bonds and stocks in 2022.”

The bank details five reasons why it is still necessary to monitor the risk of inflation:

First, from a global perspective, initial interest rates fell more and deeper than expected. In the US, the Federal Reserve cut the federal funds rate by 50 basis points on the grounds of falling inflation to prove its aggressive policy shift.

Deutsche Bank said that although what the Federal Reserve said is true, history shows that the easing cycle is exactly when it is necessary to be cautious about inflation. The report said, “If future inflation is indeed above target, then this may force the Federal Reserve to maintain a restrictive monetary policy for a longer period of time.”

Second, the worsening geopolitics in the Middle East triggered a significant rise in commodity prices. Markets are ready for a possible disruption in crude oil production in the region after Iran's missile attack on Israel sparked promises of retaliation.

Brent crude rose sharply in early October, reaching a high of $80 per barrel. Deutsche Bank notes that if Israel destroys Iran's oil facilities, analysts expect the price to reach $200 per barrel. At the same time, industrial metals such as copper have also risen sharply.

Third, as the economy shows signs of resilience, which is likely to keep inflation high, the possibility of a US recession is waning.

The analyst wrote, “While the good news on growth is welcome, it also means that economic demand and inflation are likely to be stronger than they would have been without it.”

Fourth, the previously released CPI data for September surprised investors.

Not only was the inflation data higher than expected, but the increase in core CPI also recorded the fastest increase in six months, rising 0.31%. The three-month annualized growth rate of core CPI rose to 3.1%, compared to 2.1% in August.

Deutsche Bank wrote, “Although this is just a report, it reminds us that inflation is likely to last longer, and that the more sticky categories in the CPI basket are supporting inflation. For example, the Atlanta Federal Reserve's sticky CPI index reached its highest level in five months.”

Fifth, the growth in the money supply is still accelerating. The bank said that the increase in this indicator can be interpreted as an early warning sign that inflation may remain high. Deutsche Bank notes that was the case in the post-pandemic period, although it did rise from a low base.

The company cites the fact that in August, the US M2 money supply increased 2.0% year over year, the highest growth rate since September 2022.