2022: The Year of Inflation
As we approach the end of the year, undoubtedly the top story for the economy is inflation, with the increase in consumer prices reaching levels not seen since the 1970s. Consumers are feeling the pain as they try to manage budgets in the face of increased costs in all expense categories. A broader concern is that the high prices will lead to reduced consumption, raising the risk of recession. How much longer will we contend with high inflation? First, this environment has no historical precedent to make comparison with so there will be considerable uncertainty. Second, assessing inflation can be uniquely challenging because of how personally the effects are felt. Therefore, we emphasize taking special care to rely on a wide range of data to support our forecast and maintain caution against negative surprises. Ultimately, our view is that inflation in the US has peaked and is starting a downward trend which will continue throughout 2023, falling below 4.0% by the end of next year.
Where is Inflation Now?
We think that it is more likely inflation is falling based on the most recent batch of data and Federal Reserve statements. October was the first evidence of Fed policy leading to lower inflation, with broad-based core goods prices declining. Headline CPI came in at 7.7% year-over-year, down from 8.2% in September and the 9.1% high point reached in June. Core CPI fell to 6.3% from 6.6% in September. Key housing readings (primary rents and owners’ equivalent rents) experienced a steep drop off, among the largest since the early 1990’s. Goods prices saw their prices fall month to month across the board, including furniture, apparel, medical services, used and rental cars, and electronics. To be sure, these CPI readings are far too high and decelerating price increases is not the same as prices coming down. It will be a long time until there is relief for the consumer in the form of lower interest rates or an increase in real wages (inflation-adjusted compensation).
Can this trend continue?
We have confidence in this peak-inflation view because many of the inflationary pressures of 2021-22 have abated and tighter monetary policy is in place to restrain price growth:
- The Federal Reserve is determined to reduce inflation as its central objective. The impact of rate hikes is limiting corporate and consumer borrowing, especially with small businesses and the housing market. Chair Powell has clearly stated that he does not fear tipping the US economy into recession and that there is greater risk in lowering interest rates prematurely than raising them too high.
- The unprecedented monetary and fiscal stimulus from the pandemic is over, which will curb consumer spending and bank lending. With a divided Congress in place for the next two years, we see little prospect for additional stimulus.
- Supply chain issues that limited the availability of all manner of goods are rapidly receding. Container ships are no longer waiting for days at ports and trans-Pacific shipping costs indicate that capacity is back to normal.
- While the labor market has yet to react to a slowing economy, several large companies have recently announced layoffs and hiring freezes. This is expected to continue and show up in the data soon, with unemployment rising throughout 2023. While we do not want to minimize the hardship of job loss, we recognize if this occurs the weaker labor market will further reduce inflation.
What are the major threats to our forecast?
While we predict inflation will continue to trend lower, it is unlikely to be a smooth transition to a low-inflation environment. Several key obstacles remain and could quickly change the outlook:
- There is still a global energy crisis, with the Russian-Ukraine war and the corresponding sanctions disrupting oil and gas supply worldwide. Another supply shock, similar to the one earlier this year, would be problematic.
- Geopolitical tensions remain elevated, which leads to reshoring and anti-globalization efforts, thereby raising the cost of goods.
- Long-term inflation expectations remain above target. Key to returning to the Fed’s 2.0% inflation goal is consumers believing that they will succeed.
The focus on inflation will continue into 2023. As stated above, it will take time to return to normal and we will monitor developments closely to ensure the improvements stay on track. We welcome your thoughts and wish you and your families a safe and happy Thanksgiving.