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Sticky Inflation Before the Storm
The latest Personal Consumption Expenditures (PCE) data — the Federal Reserve's preferred gauge of inflation — came in line with expectations but remained sticky and above the Fed's target. More concerning, the core PCE reading, which strips out volatile food and energy prices and is closely watched by policymakers, ran a touch hotter than anticipated.
What makes this data particularly significant is that it reflects February's economic conditions — a snapshot taken before the Iran war began. This means inflation was already proving stubbornly persistent even prior to the geopolitical disruption that has since added new inflationary pressures. The Fed now faces a complicated picture: inflation was refusing to cooperate before the conflict, and the situation has only grown more challenging since.
GDP Revision Reveals Cracks Beneath the Surface
Adding to the mixed economic signals, GDP was revised down to 0.5%. While government shutdowns and severe weather partially explain the weakness, one component stands out as especially worrisome: nonresidential fixed investment — a proxy for business capital expenditure — collapsed from 10% growth down to just 2%.
This is a significant disappointment. Business capex has been one of the primary hopes for driving economic growth this year, particularly amid the AI investment boom and reshoring initiatives. A dramatic slowdown in this category heading into earnings season raises serious questions about whether corporate spending plans are stalling in the face of mounting uncertainty.
Market Resilience: The Encouraging Counternarrative
Despite the troubling macro data, there is a genuinely encouraging story in how equity markets have behaved. The NASDAQ 100 declined roughly 6% during the first quarter — a meaningful drop, but one that appears remarkably contained when considering the circumstances. During that same period, the index's largest constituents — Microsoft, Tesla, Nvidia, Apple, and Meta — were its biggest drags.
Losing these market generals and still only experiencing a 6% drawdown suggests meaningful underlying breadth and resilience. Not long ago, the NASDAQ 100 was trading around 23,000; it has since bounced back to approximately 25,000. The market's ability to absorb bad news from its most important names without cascading into something far worse is a constructive signal for the rest of the year.
The Inflation Gauntlet Ahead
Looking forward, the immediate focus shifts to the Consumer Price Index (CPI) report. Market expectations suggest the headline number could surge above 3%, up sharply from 2.4% the prior month — potentially the largest year-over-year jump in two years. This would reflect Americans directly shouldering higher energy costs driven by the Iran conflict.
The University of Michigan consumer sentiment survey will also provide valuable, more timely data on how households are adjusting their inflation expectations in the wake of geopolitical developments. There are already signs of deterioration, particularly in longer-term inflation expectations — a troubling development because once consumers begin expecting persistent inflation, it tends to become self-reinforcing through wage demands and purchasing behavior.
The Global Dimension
The inflation challenge is not confined to the United States. Central banks worldwide are grappling with how to respond to the new geopolitical reality. South Korea's central bank faces its own balancing act — strong semiconductor demand from companies like Samsung and SK Hynix has helped offset some economic headwinds, but the broader inflation pressures remain.
China presents an entirely different case. While much of the world battles inflation, China has been contending with disinflationary — and by some measures, deflationary — pressures. Its Producer Price Index (PPI), which measures factory gate prices, has been in deflationary territory since 2022, meaning China has effectively been exporting deflation to the rest of the world. There are now signs this could reverse, with PPI potentially returning to inflationary territory. If China stops exporting deflation, it removes one of the few counterbalancing forces that has helped temper global price pressures.
A Precarious Balance
The current economic landscape presents a tension between two narratives. On one hand, inflation data is running hot even before accounting for war-driven energy price shocks, GDP is weakening, and business investment is slowing sharply. On the other, equity markets are displaying surprising resilience and underlying breadth that suggest investor confidence has not been fundamentally broken.
The coming weeks — through CPI data, earnings season, and evolving geopolitical developments — will go a long way toward determining which narrative prevails. The Fed, already boxed in by sticky inflation and a slowing economy, faces an unenviable set of choices with no easy path forward.