Part of the reason why 2022 was so tough for investors was the sheer acceleration and magnitude of interest rate rises throughout the year. With inflation ballooning to 40‑year highs, the US Federal Reserve (Fed) embarked on delivering some of the sharpest sets of interest rate hikes in recent history. However, with recent inflation numbers showing signs of weakening, we are expecting the Fed to begin to slow and then pause its tightening cycle.
But why should inflation fall in 2023 and not enter a 1970s type spiral? We believe that inflation is likely to peak and fade from highs, in part driven by the same factors that contributed to the initial inflation spike.
Supply chain issues driven by the pandemic are now fading fast as China reopens and the world learns to live with COVID. While we have not resolved all the complex issues surrounding global supply chains—which broke down completely at the peak of disruption—huge progress has already been made, with supply conditions improving markedly.
At the same time, demand is falling and unemployment rising, given higher costs and an uncertain growth outlook.
Commodity prices have continued to weaken. Oil is trading at around USD 80 a barrel currently, while the forward curve points to a range of USD 60 to USD 70 per barrel further in the future. Gasoline prices likewise are flat, year on year, while other commodity prices have also eased back from their highs.
These factors take time to feed into neutral and then potentially disinflationary forces, but we expect that by summer we are likely to be at such a point, even before other disinflationary forces stemming from a low‑growth world begin to exert an influence. If inflation falls below the fed funds rate, this historically indicated a peak of the monetary tightening cycle.
This post was funded by T. Rowe Price
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