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.