AMSCI NEWSLETTER December 2022

Inflation appears to finally be easing in the United States, but the Federal Reserve is continuing to tighten monetary policy.

Prices in November were 7.1 percent higher than they were a year earlier – a steep rise, but down from the spring and summer. Year-over-year inflation hit a high of 9.1 percent in June before decreasing each month since then. In October, it was 7.7 percent.

Core inflation, which excludes the volatile food and energy sectors, was at 6 percent in November, down from 6.3 percent in October and a recent high of 6.6 percent in September.

“Inflation was terrible in 2022, but the outlook for 2023 is much better,” the chief economist for Comerica Bank said to the Associated Press. “Supply chains are working better, business inventories are higher, ending most of the shortages that fueled inflation.”

With prices increasing not quite as fast as they have been, the Federal Reserve in December ended its streak of four straight 0.75-point interest rate hikes. The Fed, however, still boosted rates by 0.5 points, bringing the target range for the Federal Funds Rate to 4.25 to 4.5 percent, which is the highest it has been in 15 years.

“Recent indicators point to modest growth in spending and production,” the Fed’s Federal Open Market Committee said in announcing the latest rate increase. “Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures. Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are contributing to upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.”

This was the seventh rate increase of the year, and the announcement stated, “The Committee anticipates that ongoing increases in the target range will be appropriate.” Fed Chairman Jerome Powell added, “we have more work to do.”

“It will take substantially more evidence to give confidence that inflation is on a sustained downward path,” Powell said.

With rate hikes likely to continue in 2023, some critics are warning that the central bank is being over-aggressive and is likely to push the country into a recession. Part of the difficulty is that monetary policy has a delayed impact – Powell, himself, acknowledged that “the full effects of our rapid tightening so far are yet to be felt” – so the country might learn in a few months that it has overdosed on rate hikes. In addition, global factors, such as war and supply chains, affect the economy regardless of how high or low interest rates are.

The chief U.S. economist at Oxford Economics, in comments to the Associated Press, described his interpretation of the Fed’s attitude as, “We’re going to break something. We’re going to break inflation or we’re going to break the economy.”

The labor market, so far, does not appear to have been affected by higher interest rates, with the nation’s unemployment rate remaining at 3.7 percent in November and the economy creating 263,000 jobs during the month, the Bureau of Labor Statistics reported.

One of the bankers who voted for the most recent rate hike, Federal Reserve Bank of New York President John Williams, predicted that this could soon change, however. Williams suggested in a late-November speech at the Economic Club of New York that unemployment could reach 5 percent in 2023 as the Fed continues to try to rein in inflation, which he described as the “number one economic concern across the globe.”

“Inflation is far too high, and persistently high inflation undermines the ability of our economy to perform at its full potential,” Williams said, according to Financial Times.

The markets reacted negatively to the Fed’s hints at more rate increases, with both the Dow Jones Industrial Average and the S&P 500 Index falling by more than 3 percent over the two days following the announcement. As of Dec. 16, the Dow was down 9.6 percent on the year, while the S&P had recorded a year-to-date loss of 19.2 percent.

Confidence in the economy appears to be slipping, according to some measures. On the business side, the Institute for Supply Management’s Purchasing Managers Index fell to 49 in November, dipping below the 50 threshold that indicates growth in the manufacturing sector. The index has decreased for three months in a row, has not risen since May, and is now at its lowest level since May 2020.

“With Business Survey Committee panelists reporting softening new order rates over the previous six months, the November composite index reading reflects companies’ preparing for future lower output,” the chair of the institute’s Manufacturing Business Survey Committee said.

Consumer confidence is also down, according to The Conference Board’s November Consumer Confidence Index, and the board’s senior director of economic indicators said, “Inflation expectations increased to their highest level since July, with both gas and food prices as the main culprits. Intentions to purchase homes, automobiles, and big-ticket appliances all cooled. The combination of inflation and interest rate hikes will continue to pose challenges to confidence and economic growth into early 2023.”

The University of Michigan’s Index of Consumer Sentiment, though, showed a small gain in confidence in November, but it is still “low from a historical perspective.”

Housing starts declined by 4.2 percent from September to October and were down by 8.8 percent year-over-year, the Census Bureau and the Department of Housing and Urban Development reported. Existing home sales decreased in October for the ninth straight month, according to the National Association of Realtors, falling by 5.9 percent from September and by 28.4 percent from October 2021.

“More potential homebuyers were squeezed out from qualifying for a mortgage in October as mortgage rates climbed higher,” the association’s chief economist said. “The impact is greater in expensive areas of the country and in markets that witnessed significant home price gains in recent years.”

The dollar on Dec. 16 was trading at 0.94 euros, 0.82 pounds, 136.53 yen and 6.97 yuan.

The debate continues over whether the Fed can guide the economy away from the Scylla of inflation without steering it into the Charybdis of recession. The holiday shopping season could provide useful indicators regarding pricing, purchasing and employment, but the first quarter of 2023 might present some numbers that are difficult to interpret. Q1 economic statistics have often skewed lower in recent years, especially when large parts of the country are hit by major winter storms. One likely positive for the global economy is that China has started to back away from its zero-Covid policies, which could ease supply chain and other economic pressures. However, if cases and deaths increase dramatically, the possibility remains that the country might return to hard lockdowns. Russia’s invasion of Ukraine, meanwhile, continues to put pressure on the food and energy markets, though gas prices in the United States have dropped by nearly $2 per gallon since June, according to AAA.