November’s inflation data confirmed what many economists had been expecting: inflation rates are likely to have peaked, bringing relief from the highest cost-of-living rise in more than 40 years. That’s the positive side of Tuesday’s latest consumer price index. The broad basket of goods and services saw prices rise just 0.1% last month, up 7.1% year-on-year. Even if the inflation rate is still extraordinarily high, it is widely agreed that the peak has been passed. “Inflation was terrible in 2022, but the outlook for 2023 is much better,” said Bill Adams, Comerica’s chief economist. “Supply chains are working better, corporate inventories are higher, ending most of the shortages that fueled inflation in 2020. Energy price increases have moderated somewhat in recent months, and food prices also fell slightly in November.” In fact, the weak CPI reading was due to a wide range of costs either falling or slowing. Energy prices initially fell by 1.6%. Used car prices, a key driver of inflation this cycle, fell 2.9%. Bacon fell 1.8%, seafood fell 1.4% and airfares fell 3%. And workers finally got a break, with inflation-adjusted average hourly wages up 0.5% for the month, though they’re still down almost 2% over the past year. There is also hope that geopolitical forces could help bring down inflation. If China opens up further and moves away from its zero-Covid policy, it should provide a disinflationary boost. What happens from here, however, is the hard part. A ‘fairly worrying’ trend The US Federal Reserve’s series of rate hikes – six in total, raising the central bank’s short-term benchmark rate by 3.75 percentage points, and more to come – has yet to filter through to the economy. Central bank officials are fond of saying that policy adjustments come with “long and variable lags” that typically don’t start for at least a year. In fact, the only sector that rate hikes have seemed to hit so far seems to have been housing. With much monetary tightening still in the pipeline, the accompanying economic slowdown of weaker inflation is yet to come. Fed critics fear rate hikes may have gone too far and could weigh heavily on the economy once inflation eases. “The deceleration in inflation appears to be more driven by post-pandemic normalization (finally) than it appears to be in 425 [basis points] of rate hikes (including tomorrow’s likely 50 basis point hike) that the Fed has implemented are coming into effect,” wrote Josh Jamner, investment strategy analyst at ClearBridge Investments. “This is actually quite concerning,” he added, 2023 is still looming and the economy appears to be slowing on its own, leading to increased risks of recession in the year ahead, in our view.” Economists also largely agree that a recession is likely next year. Most characterize the expected contraction. That’s believable given the Atlanta Fed reports Q4 GDP growth of 3.2%, which would be the best of the year, but the economy has essentially never had one Policy tightening seen, especially when factoring in the $95 billion a month reduction in the Fed’s bond holdings. As inflation slows and the economy cools, there is reason to be wary that this year’s “flat” proclamation could match the 2021 proclamation of statements by many in the economic community, including the Fed, that inflation would be “temporary”. “There is a significant risk that monetary policy has become too tight given inflation’s momentum towards normality,” said PNC Senior Economist Kurt Rankin. “But it’s a risk the Fed is clearly willing to take, as any smoldering inflation that isn’t fully eradicated could do far more damage to the US economy than the mild recession PNC believes is likely.” If the recession turns out to be steeper and longer than expected, markets and political forces could put pressure on the Fed to start easing again. “It’s possible we’re on our way to 2% inflation because there’s a recession next year,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. “In this era of transparency and policy backdrop, I cannot imagine the calls for easing when the economy is in free fall next year.” The Fed concluded its two-day policy meeting on Wednesday, with markets broadly expecting hikes the federal funds rate by 0.5 percentage points. That would bring the short-term credit benchmark to a target range of 4.25% to 4.5%, its highest level in more than 15 years. However, following the CPI report, traders have priced in a lower “tail rate” or end point for Fed rate hikes. The market now expects the central bank to rise to around 4.84% before the stop, down from the recent high of 5%.