Why the November inflation report is key to Fed rate hikes, stocks and the economy

Americans are grappling this year with record gas prices and skyrocketing food costs in a cost-of-living crisis reminiscent of the inflationary 1980s.

Annual inflation, as measured by the consumer price index (CPI), hit a four-decade high at 9.1% in June. But by October it had slowed to 7.7%.

Investment banks and economists expect the trend of slowing inflation to continue, but that prediction will be put to the test this week with the release of November CPI data and the Federal Reserve’s latest interest rate decision.

Aneta Markowska, Chief Financial Economist at Jefferies wealth that it expects Tuesday’s CPI report to show annual inflation falling to 7.2% in November. Inflation will continue to fall next year, she said, but warns it may not meet the Federal Reserve’s 2% target without “pain”.

“I think inflation is going to slow down very linearly and then plateau,” Markowska said, arguing that some inflation is already burned into the labor market, as evidenced by hourly wages, which have risen by 7.8% annually over the past month had risen.

The Fed is facing a “tradeoff” between persistent inflation and a recession, having failed to raise interest rates last year when consumer price hikes first became a concern, it said.

“Avoiding pain is not an option here. It’s just not on the menu,” she said. “The menu says, ‘Shall we have some 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 falling inflation may not be enough to keep the US economy out of recession. Here’s what other top investment banks, economists and analysts expect from this week’s CPI report, the Fed and the US economy.

What to expect from the CPI report: A cooler November

Inflation has hit consumer wallets hard this year, but 2023 is likely to bring some relief.

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Morgan Stanley’s chief U.S. economist Ellen Zentner said in a research note on Friday that lower used and new car prices — as well as transportation, medical and accommodation costs — should lower year-on-year CPI inflation to 7.3% in November.

As Americans shift spending from goods to services like travel as pandemic restrictions ease around the world, Michael Gapen, chief economist at Bank of America, also predicted inflation fell to 7.3% year over year last month. However, in a research note on Thursday, he said housing inflation — which is based on rent prices and how much homeowners would pay to rent their homes — “could remain sticky until sometime next year.”

Such housing inflation is measured with a lag, so this component of the CPI may remain elevated despite falling home prices. And food prices, which rose 10.9% year-on-year in October, will also remain high, according to the economist – partly due to high logistics, storage and labor costs.

Goldman Sachs chief economist Jan Hatzius said in a research note on Sunday that he expects CPI inflation to come in at 7.2% yoy in November, thanks in large part to lower gasoline prices. The average price of a gallon of gasoline peaked at $5.01 in June but has fallen 34% in the months since to just $3.26, according to the American Automobile Association.

Hatzius forecast used car prices to fall 3%, clothing prices to fall 1% and hotel prices to fall 1% in November inflation data. However, he also expected airfares to recover by 2%.

The future of the Fed’s inflation fight

While most investment banks are cautiously optimistic on Tuesday’s CPI report, all eyes will be on the Federal Reserve and Chair Jerome Powell on Wednesday. Powell will hike interest rates this week and into next year even if CPI data show inflation is falling, experts said wealth.

“The Federal Reserve is set to hike interest rates again for the seventh straight day, but appears poised to hike rates by half a percentage point at each of the past four meetings, rather than the outsized three-quarters-of-a-point move. said Greg McBride, chief financial analyst at Bankrate.com. “Although the Fed will move at a more typical pace, they will still raise rates now and into 2023…at a more usual pace.”

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Danielle DiMartino Booth, CEO and chief strategist at economic research firm Quill Intelligence, also expects the Fed to hike rates by 50 basis points on Wednesday.

“It’s still a sizeable hike that will continue to wreak havoc on interest-rate sensitive sectors like real estate and autos,” she said. “A half-point rate hike is twice as fast as markets were getting used to before Jerome Powell launched his wrecking ball earlier this year to curb runaway inflation.”

DiMartino Booth, who spent nine years at the Federal Reserve Bank of Dallas, believes investors shouldn’t focus too much on the rate decision. Instead, they should keep an eye on Powell’s Wednesday press conference and his tone, which is crucial to anticipating what will happen next in the markets.

It all boils down to “which Jerome Powell comes along,” DiMartino said — “a kind, gentle, and scripted dove who’s ready to turn or a hawkish Powell who’s not afraid to rock the markets.”

If Powell is viewed as dovish by investors, shares could rise. But when he’s seen as a hawk, it’s a different story.

For now, the money is with Powell to be more hawkish, or as Jefferies’ Markowska put it, “less dovish” than in recent meetings. DiMartino even warned that despite the recent fall in inflation, Fed officials are ready to “squeeze the excesses out of the markets” with rate hikes.

Too little too late

Markowska and DiMartino Booth both fear the Fed can no longer achieve a “soft landing” – one that tames inflation without triggering a recession.

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“Hopes for a soft landing have been dashed,” DiMartino Booth said, arguing that the job market is beginning to show cracks as initial jobless claims and layoffs soar. “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 keep raising rates, increasing the likelihood of a “global financial crisis.”

Markowska didn’t go so far as to predict a “global financial crisis,” but she does expect the Fed to “probably do quite a bit of damage to the economy.” Some investors have 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 they [the Fed] have no intention of throwing the economy into recession…wishing to avoid something doesn’t mean they will actually successfully avoid it,” she said.

Markowska added that “at some point” the Fed will be forced to acknowledge the need to raise the unemployment rate well above its current year-end target of 4.4% for 2023. Doing so through additional rate hikes would help the Fed slow the economy and bring inflation down to its 2% target, but it would come at a high cost.

“It’s going to be a very difficult political environment for Powell,” Markowska said. “He’s going to face a lot of headwind.”

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