Americans have struggled this year with record gasoline prices and skyrocketing food costs in a cost-of-living crisis reminiscent of the inflationary 1980s.
Year-on-year inflation, measured by the consumer price index (CPI), reached its highest value in four decades in June, amounting to 9.1%. But by October it had slowed to 7.7%.
Investment banks and economists expect the trend of slowing inflation to continue, but that forecast will be tested this week with the release of November CPI data and the Federal Reserve’s latest interest rate decision.
Jefferies Chief Financial Economist Aneta Markowska said Luck expects Tuesday’s CPI report to show year-on-year inflation eased to 7.2% in November. Inflation will continue to fall next year, she said, but warned that it may not reach the Federal Reserve’s 2% target without some “pain.”
“I think inflation will slow down, very linearly, and then it will stop,” Markowska said, arguing that some inflation is already being fed into the labor market, as evidenced by hourly wage growth at a 7.8 percent annual rate last month .
She explained that the Fed faces a “trade-off” between persistent inflation and recession after failing to raise interest rates last year when rising consumer prices became a problem.
“Avoiding pain is not an option here. It’s just not on the menu,” she said. “It’s on the menu: ‘Do we want a little pain real quick [a recession]? Or maybe we wait and then deal with more pain down the road [persistent inflation]?’”
Markowska has company in warning that lowering inflation may not be enough to keep the US economy out of recession. Here’s what other leading investment banks, economists and analysts expect from this week’s CPI, Fed and US economy report.
What to expect from the CPI report: A cooler November
Inflation has hit consumers’ wallets hard this year, but 2023 is likely to offer some relief.
Morgan Stanley’s chief U.S. economist Ellen Zentner said in a research note Friday that lower prices for used and new cars — as well as transportation, medical and housing costs — should push year-on-year CPI inflation down to 7.3% in November.
As Americans shift their spending from goods to services such as travel as pandemic restrictions ease around the world, Bank of America Chief U.S. Economist Michael Gapen also predicted that year-on-year inflation eased to 7.3% last month . However, he said in a research note Thursday that shelter inflation — based on rent prices and what homeowners would pay to rent their homes — “could remain sticky until some time next year.”
Such shelter inflation is measured with a lag, so that despite falling home prices, this component of the CPI may remain elevated. According to the economist, food prices, which rose by 10.9% in October compared to the previous year, will also remain high – partly due to the high costs of logistics, storage and wages.
Goldman Sachs Chief Economist Jan Hatzius said in a research note on Sunday that he expects year-over-year CPI inflation of 7.2% in November, driven in part by lower gasoline prices. The average price for a gallon of fuel peaked at $5.01 in June, but in the following months it fell 34% to just $3.26, according to the American Automobile Association.
Hatzius forecast a 3 percent decline in used car prices, a 1 percent decline in clothing prices and a 1 percent decline in hotel prices in the November inflation data. He also expected a 2% increase in air ticket prices.
The future of the Fed’s fight against inflation
While most investment banks are cautiously optimistic about Tuesday’s CPI report, all eyes will be on the Federal Reserve and Chairman Jerome Powell on Wednesday. Powell will raise rates this week and next year even if CPI data reveals inflation is falling, experts say Luck.
“The Fed will raise rates again for the seventh consecutive meeting, but it appears poised to raise rates by one-half of a percentage point rather than by a whopping three-quarters of a point at each of the last four meetings,” said Bankrate’s chief financial analyst .com Greg McBride. “While the Fed will move at a more typical pace, it will still raise rates now and into 2023 … at a more typical pace.”
Danielle DiMartino Booth, CEO and chief strategist at economic research firm Quill Intelligence, also expects the Fed to raise interest rates by 50 basis points on Wednesday.
“It’s still a sizable lift that will continue to wreak havoc on interest-sensitive sectors like housing and autos,” she said. “The half-point rate hike is twice the pace markets were used to before Jerome Powell swung his wrecking ball earlier this year to slow out-of-control inflation.”
DiMartino Booth, who spent nine years at the Federal Reserve Bank of Dallas, thinks investors shouldn’t focus too much on the rate decision. Instead, you should keep an eye on Powell’s press conference on Wednesday and his tone, which is key to gauging what will happen next in the markets.
It all depends on “which Jerome Powell emerges,” DiMartino said — “a kind, gentle and precise dove ready for a turnaround, or a Powell hawk who’s not afraid to shake up the markets.”
If investors view Powell as a dove, stocks could rise. But if it turns out to be a hawk, that’s another story.
For now, the money is on Powell to be more hawkish, or as Jefferies’ Markowska put it, “less dovish” than in recent meetings. DiMartino even warned that Fed officials are willing to “squeeze the excess” out of the markets by raising interest rates, despite the recent drop in inflation.
Too little and too late
Markowska and DiMartino Booth worry that the Fed can no longer achieve a “soft landing” where inflation is tamed without triggering a recession.
“Hope for a soft landing has been dashed,” DiMartino Booth said, arguing that cracks are beginning to show in the labor market, with initial jobless claims and layoffs rising. “The Fed’s efforts have already pushed the US economy into recession.”
DiMartino Booth also argued that “sticky housing inflation” will keep inflation high next year, meaning the Fed will be forced to continue raising interest rates, raising the possibility of a “global financial crisis.”
Markowska didn’t go so far as to predict a “global financial crisis,” but she expects the Fed is likely to “cause quite a bit of damage to the economy.” Some investors had been lulled into a “false sense of security” by falling inflation since June, she said, warning that a recession was likely.
“The problem is that even if [the Fed] they have no intention of putting the economy into recession … the desire to avoid something does not mean that they will actually successfully avoid it,” she said.
Markowska added that “at some point” the Fed will be forced to recognize the need to raise the unemployment rate significantly higher than its current target of 4.4% at the end of 2023. This, with additional rate hikes, would help the Fed slow the economy and reduce inflation to its target of 2 %, but this would have a high cost.
“It’s going to be a very difficult political environment for Powell,” Markowska said. “He’s going to get hit a lot.”