12.13.2022 This morning’s CPI report represents a turning point for the Federal Reserve’s battle against inflation. US price growth eased to 7.1 per cent in November, its slowest annual reading since last year. The report blew away economists’ expectations of 7.3 per cent. The index ticked up just 0.1% in November, helped by pullbacks in apparel, energy and utility prices. Core CPI (ex food and energy) expanded six per cent over the 12 months through November. The national average price for a gallon of unleaded gasoline skidded more than 50 cents to $3.47 by the end of November. For now, let’s celebrate that good news.
It appears annual inflation peaked in June and has steadily eased, with each consecutive monthly reading incrementally lower. It’s also encouraging that actual inflation beat economists’ expectations by coming in lower for the last two consecutive months.
Jay Powell may have gotten a late start out of the gate, but the Fed chairman is taking his inflation fight seriously. His Fed has embarked on one of the most aggressive tightening cycles in recent memory, pushing the overnight rate from 0.25 per cent to four per cent in 11 months. Now, the Federal Open Market Committee is poised to raise overnight rates to 4.5 per cent tomorrow, representing its highest level since 2007. One side effect of higher rates: we expect tighter financial conditions will likely push the US into recession next year.
While equity and bond investors are cheering, US central bankers are breathing a collective sigh of relief. The downward trend in price growth undoubtedly takes some pressure off the Fed. As of yesterday, investors anticipated overnight rates would peak at five per cent. That estimate has been ratcheted back to 4.75 per cent, with easing on tap for the second half of next year.
Investors have slashed their inflation expectations also, with next year’s reading approaching two per cent. That represents a nearly 0.8 per cent cut in 2023 inflation since November. Longer term, investors have reduced their one-year inflation rate expectations by nearly 0.5 per cent.
Today’s good news was celebrated by both stock and bond investors. The benchmark 10-year note yield declined 0.2 per cent to below 3.5 per cent, and the 2-year note yield, a closer barometer of monetary policy expectations, slid more than 0.25 per cent. Stocks, meanwhile, advanced more than one percent, as of midday, after surging more than 700 points initially.
Bottom Line: We’re celebrating the favorable trend in price growth and anticipate the glidepath toward 3.5 per cent should be relatively straightforward. Getting inflation back into the twos will be hard. We expect inflation to linger around three per cent through 2023. For now, let’s celebrate the good news.