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LAST WEEK’S INFLATION report did the bulls no favors. The latest reading on the Consumer Price Index showed a larger-than-expected September rise, mostly due to housing data, which tend to respond slowly to higher interest rates. Then came Friday’s University of Michigan Consumer Sentiment Survey, which showed an unexpected jump in inflation expectations over the next year and next five years. Result: Bond yields climbed and stocks finished the week lower.
But there’s also good news: Among economists, expectations for 2023 inflation look nothing like what we’ve endured over the past year. Goldman Sachs, for instance, expects both headline CPI and the core rate—which removes the volatile food and energy components—to be under 3% for the 12 months through December 2023. Analysts at Bank of America forecast full-year CPI of 2.2% for 2024.
Meanwhile, it’s likely the Federal Reserve will be almost through its rate-hike cycle in less than two months. Following the Dec. 14 meeting, the Fed’s policy rate should be near 4.6%, based on market pricing, with a peak rate near 5% expected in next year’s second quarter.
Indeed, by the middle of 2023, there could be mounting job losses as the economy stumbles amid much tighter borrowing conditions. Bank of America forecasts a rising unemployment rate and upward of 200,000 jobs lost per month in next year’s second quarter. Other research firms, while perhaps not predicting a recession, are at least lowering their S&P 500 earnings outlook.
Given a steep deterioration in economic activity and corporate profits, the Fed might be forced to put an end to its rate increases. While much depends on what’s happening to CPI, if the economy does indeed slow sharply over the coming quarters, the Fed may even have to cut rates a little late next year. But don’t expect any hint of that dovish turn since the very words used by the Fed are part of its rate policy.
The upshot: The headwind of rising interest rates will soon be over and, for stock investors who are patient just a little longer, better days are likely at hand. It’s a good reminder that stocks have historically been a good way to combat inflation.
Reading this I can’t help but being reminded of the Bond King (Bill Gross) who made a fortune betting on interest rate changes. He was the king, until he wasn’t.
“Goldman expects CPI to be under 3% through 2023…”
Or not – and then what?
No one is talking about this but they should:
What a $1 Trillion Deficit Means to the U.S. Economy (manhattan-institute.org).
Excerpts:
‘…CBO data shows that government debt—39% of GDP in 2008—has already doubled, to 78%. The debt-to-GDP ratio is projected to reach 105% within a decade, and 194% after three decades.
‘…The federal government currently pays an average interest rate of 2.3% on its debt…far below the previous average rates of 10.5% (1980s), 6.9% (1990s), and 4.8%(2000s).CBO assumes that interest rates paid on the debt will remain historically low—rising to 3.4% over the next decade and 4.2% over 30 years. What if interest rates rise higher?
‘…A 1% interest-rate increase would add nearly as much government debt—$11 trillion—as the 2017 tax cuts, extended over 30 years.
‘…The debt-to-GDP ratio is projected to reach 194% of GDP in 30 years under current policy. If interest rates wereto rise to 6.9%—the average rate paid by the federal government on its debt in the 1990s—the U.S. debt-to-GDP ratio would move closer to 250%.
‘…A recent analysis…shows that each percentage-point increase in federal debt as a share of GDP raises the interest rate on the 10-year bond by four basis points—even if other economic factors are currently
pushing rates back down.
‘…It is highly unlikely that offsetting factors holding interest rates down…could counter the debt-to-GDP ratio effect…’
I’ve been investing since 1979, and have yet to see a consensus of economists predict future inflation correctly.
How about you go back 12 – 24 months and see how well the oracles of Goldman Sachs and Bank of America predicted our current inflation?
I don’t put much stock in Goldman Sachs or Bank of America inflation forecasts. This time last year, were they forecasting 2022 inflation of 6% or so??
It’s a well done article, but I wonder if we know that “the headwind of rising interest rates will soon be over”.
I might make the argument that:
A good list of variables that can wreck or diminish this positive outlook. Another variable is US mid term elections which might help or hinder economy efforts.
While I agree that inflation will probably be over sometime next year, I have to wonder how a recession will impact the stock market.
With the expectations of inflation curbing next year, I just don’t see the ten year getting much above 4.25% or maybe not 4%.
At some point, treasuries out the yield curve may offer a good opportunity too.
And when the Treasury market calms, we should see a return to the diversification benefit of owning bonds.