Federal Reserve stamp on dollar.

Will the Fed ease off as US inflation cools?

19 January 2023

Please note: The article does not constitute advice or any form of investment recommendation.

The latest inflation data to come out of America suggests that price pressures are continuing to ease – with the US Consumer Price Index falling for a sixth consecutive month in December, and inflation falling to its lowest level in more than a year. 

Although annual US inflation is still at an uncomfortably high 6.5%, this represents a notable decline from the 9.1% figure posted back in June. 

Why does it matter? As the world’s most influential economy, events in the US have a ripple effect, particularly when it comes to the global battle against inflation. 

The ‘disinflation party’ 

The slowing of inflation clears the way for the US Federal Reserve (Fed) – the central bank that determines interest rates across the country – to reduce the size and scope of any future interest rate rises in 2023.  

Many analysts now believe that a February rate hike is likely to be contained at just 0.25%, rather than the 0.5% previously forecasted. 

US interest rates currently stand in a range of 4.25% to 4.50% (after seven rate hikes in 2022), with markets now forecasting a peak upper target of just below 5% later in 2023.  

As well as global stock markets advancing on this inflation data, bond investors have also been buoyed by the so-called “disinflation party” – with bond yields retreating on government bonds, and spreads for high-yield and investment-grade corporate debt tightening. Both are seen as positive indicators in bond markets. 

As always, it’s worth remembering that past performance is never a guaranteed indicator of future performance.  

All eyes on the Fed 

As we covered in our previous article – The Fed opts for another hike – the global economic outlook remains far from certain. But all eyes will be on the Fed in the coming weeks and months as it continues to walk the inflation-recession tightrope, especially as its every move is closely watched due to the key role it plays in the global economy. 

However, more evidence may yet be needed of slowing US inflation before the Fed seriously considers halting or even reversing interest rate hikes, especially when it needs to factor in competing pressures of strong domestic wage growth and a tight jobs market.  

Yet, markets are currently pricing in a 0.5% cut to US interest rates by year-end – after reaching expected highs of 5% – but there is little to suggest this is on the Fed’s immediate agenda. Thinking further ahead, it may be signs of a weakening economy, rather than any inflation figures, that could trigger this downward move in interest rates. 

For now at least, the latest US inflation figures are certainly more positive than what we saw last year, and they lend weight to the view that any recession could be relatively shallow and short-lived.  

If the end of 2022, and the start of 2023, are a sign of things to come, then inflation-weary investors may start believing that the worst is now behind them.   

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