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U.S. inflation cooled more than expected in February, dropping to 2.8% and fueling optimism that the Federal Reserve could start cutting rates sooner rather than later. Markets initially cheered the news, with the S&P 500 (SPY) opening higher today, but enthusiasm faded as investors weighed the lingering impact of trade tensions and a still-stubborn core inflation rate of 3.1%. Futures markets are now pricing in two rate cuts this year with an 85% chance of a third, but Fed Chair Jerome Powell remains cautious, emphasizing the need to sift through short-term fluctuations before making a move. The big question: Will the disinflation trend hold, or are we looking at a temporary dip before tariffs push prices higher again?
Despite cooling inflation, investors aren't rushing to celebrate just yet. Treasury yields and the dollar climbed as traders factored in the uncertainty surrounding the Fed's next steps. While price declines in airfares, new cars, and gas have given consumers some relief, key sectors like medical care and housing are still running hot. Meanwhile, trade tensions are throwing another wrench into the mixTrump's escalating tariffs on Chinese, Mexican, and Canadian imports could reverse any disinflationary momentum in the coming months. Some economists argue the February data might be a short-lived win, warning that rising costs in global supply chains will eventually trickle down to consumers.
The Fed is now walking a tightrope. Cut rates too soon, and inflation could come roaring back. Wait too long, and the economy could tip into a slowdown. With recession fears lurking and businesses navigating policy uncertainty, all eyes are on upcoming data releases to see whether this cooling trend sticks. The producer price index and consumer sentiment reports in the coming weeks will be key indicators of where inflation is actually headed. Until then, markets are left guessing whether the Fed's next move will be a well-timed pivotor a misstep that sends shockwaves through the economy.
This article first appeared on GuruFocus.