Inflation, the Fed, and Retail Sales: Five Key Takeaways from Last Week's Data

DEWITT, Mich. - Dec. 20, 2022 - PRLog -- Equity markets fell over 2.0% last week, as market sentiment seemed to turn lower after a more hawkish Fed meeting and weakening retail-sales data, and despite better-than-expected CPI inflation data for November. Overall, the Fed (and global central banks) remain vigilant for now, but as inflation moderates and the economy softens in the months ahead, there may be less need for peak restrictive policy. While this transition may take some time, and markets could be more volatile in the near term, we may see a better market backdrop as we head toward the back half of 2023.

1. Consumer price index (CPI) inflation came in cooler than expected: We believe inflation will continue to moderate through 2023

CPI inflation data for November came in below expectations, with headline inflation of 7.1% year-over-year versus expectations of a 7.3% figure. Core inflation came in at 6.0%, also below forecasts for 6.1% and lower than last month's 6.3%. Overall, inflation is trending in the right direction, although CPI remains elevated and well above the Fed's 2.0% target. Goods inflation continues to ease, with areas like used cars, apparel and even toys showing moderating price pressures.

2. The Fed raises interest rates by 0.50% and indicates a 5.1% peak fed funds rate: We see markets and the Fed converging around a 5.0% terminal rate

As expected, the FOMC raised rates by 0.50% at its December meeting last week, bringing the fed funds rate to about 4.5%. Perhaps what was less expected by markets was that the Fed's "dot plot," or estimates of where interest rates are headed, indicated a peak fed funds rate of 5.1% in 2023.

3. The Fed indicates no rate cuts in 2023 and about 100 basis points (1.0%) of rate cuts in 2024: We believe the Fed can start to signal rate cuts by year-end 2023

While the Fed acknowledged that pausing rate hikes at some point (likely in the first quarter) was likely, Chair Powell and team noted that it was too soon to discuss rate cuts. Their own projections do not include rate cuts until 2024, and the Fed has indicated it will remain restrictive with its monetary policy until inflation clearly heads back toward 2.0%.

4. Global central banks raise rates by 0.50% alongside the Fed: We see global tightening continuing through the first quarter of 2023 before potentially pausing

Last week, the Bank of England and the European Central Bank (ECB) also raised their policy rates by 0.50%, bringing the Bank of England's target rate to 3.5% and the ECB's to 2.0%. Like the Fed, these central banks reiterated the message that further rate hikes are likely, as inflation remains well above target ranges.