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Last week I wrote about how this could be a December to remember for the global economy. And for the U.S. in particular, this is a critical week with two very important events happening that will help set the stage for 2023: the release of the latest U.S. inflation figures, and another likely interest rate hike from the U.S. Federal Reserve. Here are some thoughts on both of these anticipated events. [Note that this article was posted ahead of the Fed rate announcements. Editor’s updates are shown in italics in square brackets.]
This week we’ll get the U.S. Consumer Price Index (CPI) reading for the month of November. This is important because it will tell us whether October’s print was an aberration or the start of a trend toward inflation moderation. I believe it’s far more likely to be the latter than the former, but there is certainly fear on the part of many that inflation could be higher than hoped, given the higher-than-expected U.S. Producer Price Index print last week.
One indicator that suggests inflation could be easing is the Citi U.S. Inflation Surprise Index. After a dramatic climb in which inflation was repeatedly higher than expectations, this index has now fallen significantly, retracing much of the previous rise, as inflation has been lower than expectations. This was supported by the New York Fed’s recently released readings of consumer inflation expectations.1 Median one-year ahead inflation expectations fell to 5.2% from 5.9% the previous month – a significant drop. Median three-year ahead inflation expectations eased from 3.1% to 3%, also moving in the right direction. And median five-year ahead inflation expectations also dropped from 2.4% to 2.3%.
The Federal Open Market Committee (FOMC) meets Dec. 13 and 14, and I expect a 50 basis point hike to be announced. [In the event, this is precisely what happened.] However, I believe the FOMC’s decision on how much to hike rates this month will be far less important than what it says about the future path of monetary policy, and we will hear about that in three ways:
Having said all that, there seems to be an overarching feeling of doom in markets. The S&P 500 fell nearly 3.5% last week2 – it has been down in a downward slide thus far in December – as markets have expressed trepidation about the events this week; they are not convinced inflation is truly on the decline after having heard for too long that it is “transitory” and will soon dissipate. (It reminds me of the typical horror movie fake-out: Every time it appears that the mass murderer in the hockey mask has been killed, he gets up again to wreak more havoc; at a certain point, the audience refuses to believe he can ever be killed. I call this “Jason Voorhees Won’t Die” Syndrome, and I think this can be applied to many market participants who just can’t believe high inflation will ever go away.)
However, I put more stock in what we are seeing in the bond and currency markets. I view them as more reliable market indicators, and what they’re suggesting is that inflation is easing and that the Fed is likely to get less aggressive quickly: The U.S. dollar is rolling over, and the 10-year U.S. Treasury yield has fallen significantly.
And that leads me to our outlook for 2023. Not surprisingly, the outlook for 2023 is largely dependent on the path of monetary policy, which in turn is very reliant on the path of inflation. Our base case is that inflation will moderate, leading to a pause in central bank tightening in the first half of 2023. This should enable a recovery regime to unfold where global growth will be below trend but rising.
However, given an unemployment rate already near all-time lows, this is unlikely to represent the start of a new economic cycle. Instead, we expect rising global risk appetite to reflect a positive repricing of recession risks in terms of timing, duration, or magnitude, while we continue to assess the full impact of past monetary policy tightening, with its long and variable lags.
In this environment, we would prefer risky credit and investment-grade credit, shorter duration, value-oriented regions, and cyclical sectors. Currency preferences include the Australian dollar, Canadian dollar and Brazilian real, as we expect the U.S. dollar to continue to weaken.
However, there is the possibility (though we think it’s unlikely) that inflation remains stubbornly high. If that is the case, we assume central banks will continue tightening monetary policy for longer and would expect a longer contraction regime as a result. We would expect this to increase the probability of a global recession, resulting in worse growth and further pain in risk assets. In this environment, we would prefer to underweight equities relative to fixed income, and within equities we would favour defensives, quality, and low volatility. We would prefer government bonds and duration, and would favour the U.S. dollar.
Weekly Market Compass will be on hiatus for the next two weeks. We at Invesco wish you and your families a wonderful holiday season filled with many blessings.
Kristina Hooper is Global Market Strategist at Invesco. With contributions from Brian Levitt and Alessio de Longis.
Notes
1. Source: New York Fed Survey of Consumer Expectations, November 2022.
2. Source: Bloomberg, L.P., as of 12/9/22.
Disclaimer
© 2022 by Invesco. Reprinted with permission.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
The opinions referenced above are those of the author as of December 12, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
Forward-looking statements are not guarantees of future results. They involve risks, uncertainties, and assumptions; there can be no assurance that actual results will not differ materially from expectations. Diversification does not guarantee a profit or eliminate the risk of loss. All investing involves risk, including the risk of loss.
Diversification does not guarantee a profit or eliminate the risk of loss.
All figures are in U.S. dollars.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
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