The Longer-Term Inflation Outlook
While the Federal Reserve is waiting for more data showing actual declines in inflation, both leading indicators of inflation and macro-economic forces strongly point to lower inflation ahead.
• First, on supply-chain issues, as we show on page 53 of our Guide to the Markets, the global vendor delivery index and indices of input and output prices have all fallen sharply in recent months.
• Second, there are clear signs of a pullback in U.S. consumer spending. We expect this Friday’s September retail sales report to show a significant decline in ex-auto retail sales. If this transpires, it could imply less than a 0.1% monthly gain in real consumer spending over the last six months. Despite a sharp ramp up in credit card debt, the phase out of government pandemic programs have left many consumers strapped and we don’t expect any further relief in the form of fiscal stimulus between now and the 2024 presidential election.
• Third, the sharp increase in mortgage rates and the sharp surge in the value of the dollar should act as a significant drag on demand from both the housing and trade sectors in the quarters ahead.
• Finally, despite the market’s reaction to last Friday’s jobs report, investors need to recognize two important labor market trends. First, the labor market is gradually coming back into balance. As evidence of this, August saw a huge 1.1 million decline in job openings while the non-farm payroll gain for September, at 263,000, was the smallest increase since April 2021. Second, contrary to much market commentary on the subject, wage inflation cannot be accused of accelerating current inflation trends. The reality is that, assuming consumer prices rose 8.1% year-over-year in September, the 5.0% increase in wages over the same period can only be said to be slowing the decline in inflation rather than speeding it up.
Taking all of this into account, we expect year-over-year headline consumption deflator inflation of 5.4%, 2.7% and 2.6% in the fourth quarters of 2022, 2023 and 2024 respectively—not significantly different from the Fed’s forecasts of 5.4%, 2.8% and 2.3% over the same periods.
Investment Implications
The strange thing about this forecast is that it isn’t particularly controversial. While some feel a sharp increase in the unemployment rate will be necessary to quickly reduce inflation to 2%, a balanced look at both current economic data and future trends suggests that it is headed in that general direction with or without even more aggressive Fed action or a recession. For the Federal Reserve, it will be important at their November meeting to acknowledge progress on the road to lower inflation and to begin to signal at least a slower pace of tightening. For investors, it’s important to recognize that the real question is not whether inflation is falling but the slope of the slide. Across a range of these possible slopes, there should plenty of opportunities for those investing in financial markets today, particularly given the sharp selloff across stocks and bonds triggered by fears of a worse inflation outcome and a more hawkish Fed than is likely to prevail in the coming years.
David Kelly is chief global strategist at JPMorgan Funds.