Economists have become more skeptical about inflation in 2023.
According to the Wall Street Journal’s latest survey of economists, the average expectation is for inflation (as measured by the consumer price index) to hit 3.53% year-over-year by December. Just three months ago, the average expectation was for a 3.1% y-o-y CPI increase.
Long-time readers of my column know I do not generally put much weight in consensus expectations from an economic perspective. But I do think they’re useful for gauging sentiment, which from an investment perspective helps set the table for a positive or negative surprise. In the current environment, just about everyone expects a recession in 2023, and expectations for inflation are now going up.1
I see that as a good thing for markets. Why? Because now I think it’s even more possible that inflation and growth surprise to the upside this year.
Earlier in April, the Labor Department released CPI data confirming that inflation remains in a downtrend. CPI registered at 5% year-over-year in March, down from February’s 6% year-over-year increase and marking the smallest increase since May 2021. Services prices remain elevated, but a close look at the data reveals that much of the pressure is coming from the shelter component, which makes up one-third of CPI.
It’s important to note that shelter prices impact CPI with a significant lag. Since shelter prices measure what renters and homeowners pay for housing by including new and existing leases, it means that any meaningful declines would not show up in the CPI numbers for months. We’re showing that new leases have come down sharply in price, with an index of new leases declining at a 3-month annualized rate of slightly less than 3%. By my estimations, the shelter component should contribute significantly less to inflation starting in June and extending into the fall.
Two other key data points are bolstering the case for a better-than-expected inflation outcome this year. The first is M2 money supply declining by $130 billion in February and -2.4% year-over-year, which marks the fastest rate of decline in M2 since the 1930s (chart on the next page). Changes to the consumer price index tend to lag M2 money growth by about a year or so, which suggests we could see a significant anchoring effect on inflation in the coming quarters.
M2 Money Supply – Percent Change from a Year Ago
Source: Federal Reserve Bank of St. Louis2
The second data point worth referencing is the number of job openings in the U.S., which in February fell to 9.9 million from January’s 10.6 million. This figure is down considerably from the peak of 12 million job openings reached in March 2022 and signals that rate hikes are easing labor market pressures – particularly wage pressures – without triggering mass layoffs (at least not yet). Private data from companies like ZipRecruiter and Indeed suggest that job openings may even be declining at a faster pace than government data suggests, and the impact on average hourly earnings appears to be taking hold:
Average Hourly Earnings Growth May Have Peaked in March 2022
Source: Federal Reserve Bank of St. Louis3
Bottom Line for Investors
This column has focused on the consumer price index (CPI), but it’s worth noting that CPI is not the Federal Reserve’s preferred inflation indicator for setting monetary policy. They prefer the personal consumption expenditures (PCE) price index, which rose 5% year over year in February, and is expected to have ticked lower in March. Mark your calendars: the March release for the PCE price index is on April 28.
The reason the inflation question matters so much, of course, is because inflation data sets the stage for interest rate policy. As of today, the Federal Reserve is forecasting only one more 25 basis point rate hike in this tightening cycle, which hinges on inflation continuing in a downtrend. In my view, the table is set for inflation to continue falling – barring another commodity market shock or some other extraneous factor – and for interest rates to hit a peak, likely this summer.
1 Wall Street Journal. April 15, 2023. https://www.wsj.com/articles/economists-turn-more-pessimistic-on-inflation-ed2fd667?mod=djemRTE_h
2 Fred Economic Data. March 8, 2023. https://fred.stlouisfed.org/series/WM2NS#
3 Fred Economic Data. March 2023. https://fred.stlouisfed.org/series/CES0500000003#
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