This Week’s Blogger: Scott D. Heins, CFP®, IAG Chief Investment Officer
Toward the end of last year, expert market prognosticators continued their tradition of revealing their forecasts for the financial markets for the following year.
While they are, in my opinion, about as useful as the always entertaining Farmer’s Almanac, many of these experts predicted a rough start to 2023. Their swirling crystal balls gave them visions of market tumbles and a recession in spring with the ensuing economic recovery providing optimism into the end of the year.
Things are not going as envisioned thus far. What changed since way back in December? Traders are starting to dis inflation.
Last week’s Consumer Price Index (CPI) report provided a spark of optimism in traders’ minds. Yes, the headline annual inflation rate of 6.5% is still significantly higher than the Federal Reserve’s 2% target, but the trends in the report were clearly disinflationary.
The Federal Reserve prefers to look at inflation excluding food and energy costs because there is nothing they can do to impact the supply or demand for those resources. However, food and energy costs have a significant impact on your daily life and price increases are slowing.
In December food inflation showed it lowest monthly increase (.3%) since March 2021. The monthly inflation for food had been at .8% or higher from January 2022 through September 2022, but in October it fell to .6%, in November it fell to .5%, and last week we learned that December fell to .3%.
We know that eggs (which make up only .147% of the CPI) will do their best to boost food inflation for January, but if monthly increases can hold around .3% over the next 12 months the annual inflation rate will be a more reasonable 3.6%. That is significantly better than the 10.4% food inflation over the last 12 months.
Energy prices are even more volatile than food prices. Over the last 12 months, the monthly price change has been as high as 11% (March 2022) and as low as -5% (August 2022), resulting in an annualized 7.3% increase in 2022. Here, too, the trend is favorable to dis inflation. Energy prices have declined in 5 of the last 6 months, including December’s 4.5% decrease.
Keep in mind that March’s year-over-year change in energy prices could provide another reason to dis inflation as the 11% increase in March 2022 is hopefully replaced with a much lower growth rate in March 2023.
Food and energy only make up about 22% of the total CPI. What about the other 78%?
Shelter costs (rent or home ownership) make up 33% of the CPI and are showing little inclination to dis inflation. The monthly change in December was an increase of .8% (up 7.5% over the last 12 months). This data point could prove persistently sticky in the Federal Reserve’s efforts to dis inflation.
Commodities (clothes, cars, etc.) comprise 21% of CPI and fell by .3% in December. Year-over-year they are only up 2.1%, with used car prices falling by 8.8% over that time.
While traders enthusiastically embraced last week’s CPI report as it provided hope that the Federal Reserve could dis inflation with less economic damage than previously expected, there are still risks to this cheery outlook as inflation historically is not easily dismissed.
Energy prices could be pulled higher by greater demand from China, colder weather, or geopolitical events. Food prices could start rising due to crop damage, shipping issues, or other shortages. A stubbornly tight labor market could lead to ever-higher production costs and prices.
Despite these risks, we are generally optimistic that the Federal Reserve will eventually succeed in taming the fires of inflation they helped stoke. We also understand that inflation, once dissed, is likely to return again at some point in the future.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Any opinions are those of IAG and not necessarily those of LPL Financial. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. No strategy assures success or protects against loss. Investing involves risk including loss of principal.
Quote of the week:
Herbert Hoover: “There are only three ways to meet the unpaid bills of a nation. The first is taxation, The second is repudiation. The third is inflation.”
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