In today’s Steady Investor, we look at key factors that we believe are currently impacting inflation, market volatility, and what could be next for the markets such as:
Emerging Markets Rally Loses Steam – Over the past few months, emerging markets’ stocks and bonds have been in strong rally mode, fueled by a strong rebound in growth in emerging economies and expectations that the Federal Reserve rate was poised to stop raising rates in early 2023. The market rally appears to be over. Last week, indices of emerging markets bonds and emerging markets stocks both posted their biggest decline since early fall, with currencies also declining sharply in lockstep. So, what changed? Expectations for future Federal Reserve policy. Performance across emerging markets tends to be highly sensitive to changes in Federal Reserve interest rate policy, and ongoing strength in the U.S. labor market combined with a decelerating pace of falling inflation (explained below), have caused many investors to recalibrate their expectation for peak fed funds. Higher-for-longer-than-expected interest rates weaken demand for emerging markets assets since higher rates make debt financing more expensive for emerging markets, and also tends to strengthen the dollar – thereby weakening emerging market currencies. Weaker currencies tend to make it pricier to buy oil and other commodities that are priced in dollars, a key factor in determining growth. Even still, emerging markets are expected to post better growth in 2023 than developed countries, with the IMF predicting an average of 4% growth for developing countries versus 1.2% growth for advanced economies.1
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January Inflation Data Shows Small Improvement – The Labor Department reported last week that inflation rose 6.4% year-over-year in January, a slight improvement from December’s 6.5% rate of increase. Inflation has now decreased for seven months straight, but the latest decline was weaker than many had hoped. Looking more closely at month-over-month figures, the consumer price index (CPI) was seen increasing by 0.5% from December to January, which was markedly higher than the previous month’s 0.1% increase. Core prices, which exclude energy and food, were up 5.6% year-over-year, again only a slight improvement from December’s 5.7% year-over-year increase. The cause for concern in this latest inflation reading was not goods prices, which are firmly in a downtrend. Core prices rose at their slowest annual pace since February 2021. Its services’ prices have market-watchers and the Fed concerned, as they rose at their fastest annual pace since 1982. This inflationary pressure is a byproduct of continued strength in the labor market coupled with consumers increasingly shifting their spending from goods to services, like dining out (see next section). This inflation report essentially serves as confirmation that the Fed will raise rates at their next meeting.3
Retail Sales Rebound in January – Weakness in the December retail spending report raised a few eyebrows, as that’s typically a strong month in the holiday shopping season. Concerns were put to rest in January. The U.S. consumer returned to stores and restaurants at a solid clip in January, with retail sales rising 3% from December. Extreme winter weather was one of the major culprits for declining spending in December, which arguably meant that consumers were eager to get back out. January’s 3% month-over-month was the biggest jump in almost two years, as consumers spent more on cars, furniture, clothes, and restaurants and bars. Economists were only expecting a 1.9% increase, which underscores the idea that an expected recession could be even weaker than many thought, or simply not happen at all. Besides better weather, two other key reasons driving consumer strength were the labor market – which added a stout 517,000 jobs in January – and higher Social Security checks, which jumped by 8.7% in the new year since benefits are adjusted for inflation. January was also a better month for Covid than December, which boosted morale and consumers’ ability to get out and spend.4
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