Two is a coincidence, three is a trend

DEWITT, Mich. - Jan. 17, 2023 - PRLog -- The year started with stocks rising, bond yields falling, and the U.S. dollar weakening, a mirror image of the trends that prevailed in 2022. To validate the persistence of these better market outcomes, or to dash such hopes, all eyes were on the December inflation reading. And the data did not disappoint: It matched consensus expectations, which was a small but necessary step towards easing some of the pressures.

The consumer price index (CPI) decelerated further, with December marking the smallest annual increase since October 2021¹. Paired with the November and October data, core inflation (which excludes the volatile categories of food and energy) has now slowed for three consecutive months. And so have other measures of underlying price trends, like the Atlanta Fed's trimmed CPI, suggesting that a pattern of disinflation is emerging. Price pressures remain high, but we think the gradual cooling sets the stage for the Fed to downshift the pace of rate hikes further.

Highlights from the December inflation report

• Headline inflation fell 0.1% from the previous month, helped by a decline in energy prices and a more modest increase in food prices. Annually, CPI was up 6.5%, decelerating from November's 7.1% pace. Stripping out food and energy, core consumer prices increased by 0.3% last month and 5.7% over the last year, almost a full percentage point below its September peak¹.

Path forward

• Evidence continues to build around moderating inflation. The CPI trajectory over the past three months, together with the signal from leading indicators of inflation  (like the ISM prices paid for inputs by manufacturing and services firms), indicates that core inflation could fall to 3% by year-end.
• The path of disinflation is unlikely to be a straight line and will require the labor-market tightness to ease. But even with the ongoing strength in job creation and historic low unemployment, wage pressures have started to moderate.

Too soon to declare victory but not too soon to consider a pause

• Inflation remains well above the Fed's target, so policymakers are likely to continue pushing back against expectations for rate cuts. But they are likely to gradually soften their tone and signal the end of the Fed's most aggressive tightening campaign in four decades.

How do markets perform when the Fed pauses?

• Over the past 40 years the Fed has paused seven times after concluding a tightening cycle. Following the final rate hike, policymakers held rates steady for about six months on average (ranging from a month to a little over year) before proceeding to cut rates to stimulate the economy².

Sources: 1. Bloomberg, 2. FactSet, Edward Jones