How an Inflation Surprise Could Impact Markets

Consensus expectations are for a recession and continued inflation in 2023—but there are signs that inflation and growth may surprise to the upside. [Mitch on the Markets] How an Inflation Surprise Could Impact Markets in 2023 Economists have become more skeptical about inflation in 2023. According to the Wall Street Journal’s latest survey of economists, the average expectation is for inflation (as measured by the consumer price index) to hit 3.53% year-over-year by December. Just three months ago, the average expectation was for a 3.1% y-o-y CPI increase. Long-time readers of my column know I do not generally put much weight in consensus expectations from an economic perspective. But I do think they’re useful for gauging sentiment, which from an investment perspective helps set the table for a positive or negative surprise. In the current environment, just about everyone expects a recession in 2023, and expectations for inflation are now going up.1 --------------------------------------------------------------- [How to Protect Your Investments from Market Changes]( Inflation can be difficult for a long-term investor, as it can negatively affect the value of investments over time. I don’t recommend that you time the market. Instead, it’s essential to consider your risk tolerance and define your investing goals before making sudden moves. To help you do this, I’m offering our just-released May Stock Market Outlook Report. This report will give you an in-depth look into the current state of treasuries and stocks and the best place to invest. If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download Our Just-Released May 2023 Stock Market Outlook Report 2]( --------------------------------------------------------------- I see that as a good thing for markets. Why? Because now I think it’s even more possible that inflation and growth surprise to the upside this year. Earlier in April, the Labor Department released CPI data confirming that inflation remains in a downtrend. CPI registered at 5% year-over-year in March, down from February’s 6% year-over-year increase and marking the smallest increase since May 2021. Services prices remain elevated, but a close look at the data reveals that much of the pressure is coming from the shelter component, which makes up one-third of CPI. It’s important to note that shelter prices impact CPI with a significant lag. Since shelter prices measure what renters and homeowners pay for housing by including new and existing leases, it means that any meaningful declines would not show up in the CPI numbers for months. We’re showing that new leases have come down sharply in price, with an index of new leases declining at a 3-month annualized rate of slightly less than 3%. By my estimations, the shelter component should contribute significantly less to inflation starting in June and extending into the fall. Two other key data points are bolstering the case for a better-than-expected inflation outcome this year. The first is M2 money supply declining by $130 billion in February and -2.4% year-over-year, which marks the fastest rate of decline in M2 since the 1930s (chart on the next page). Changes to the consumer price index tend to lag M2 money growth by about a year or so, which suggests we could see a significant anchoring effect on inflation in the coming quarters. M2 Money Supply – Percent Change from a Year Ago [M2 Money Supply – Percent Change from a Year Ago] Source: Federal Reserve Bank of St. Louis 3 The second data point worth referencing is the number of job openings in the U.S., which in February fell to 9.9 million from January’s 10.6 million. This figure is down considerably from the peak of 12 million job openings reached in March 2022 and signals that rate hikes are easing labor market pressures – particularly wage pressures – without triggering mass layoffs (at least not yet). Private data from companies like ZipRecruiter and Indeed suggest that job openings may even be declining at a faster pace than government data suggests, and the impact on average hourly earnings appears to be taking hold: Average Hourly Earnings Growth May Have Peaked in March 2022 [Average Hourly Earnings Growth May Have Peaked in March 2022] Source: Federal Reserve Bank of St. Louis 4 Bottom Line for Investors This column has focused on the consumer price index (CPI), but it’s worth noting that CPI is not the Federal Reserve’s preferred inflation indicator for setting monetary policy. They prefer the personal consumption expenditures (PCE) price index, which rose 5% year over year in February, and is expected to have ticked lower in March. Mark your calendars: the March release for the PCE price index is on April 28. The reason the inflation question matters so much, of course, is because inflation data sets the stage for interest rate policy. As of today, the Federal Reserve is forecasting only one more 25 basis point rate hike in this tightening cycle, which hinges on inflation continuing in a downtrend. In my view, the table is set for inflation to continue falling – barring another commodity market shock or some other extraneous factor – and for interest rates to hit a peak, likely this summer. To protect your investments from inflation, I recommend reading our [Just-Released May 2023 Stock Market Outlook Report](. You will have access to our forecasts for the months ahead and insight into where to invest. You will also get a deeper insight into the following: - U.S. macro-outlook from San Fran Fed - Status of energy markets - What produces 2023 optimism - What’s alive for 2023 pessimists - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! 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