Inflation Is Falling, But Does It Mean That The Fed's February Decision Will Be Dovish?

The Federal Reserve Policy-making Committee will meet January 31-February 1, 2023, and their decision will be a tough one, harder than any of their choices in 2022.

✕

US Inflation

Inflation is the number one concern for the Fed, and the news is pretty good. The Fed is watching the price index for personal consumer spending excluding food and energy, while labor markets continue to show strong strength in the economy.

The United States recently released its Consumer Price Index (CPI) report for December 2022. It was mostly in line with expectations, pointing to a slowdown in both headline and core inflation. There is no doubt that the pressure has eased and inflation is coming down. The monthly total CPI fell by 0.1% in December, the first drop since June 2020. The core CPI, which removes the effects of volatile items such as food and energy, hit a monthly low of 0.3%.

On the other hand, food inflation remains stubbornly high due to Covid-induced supply chain disruptions, extreme weather conditions in some parts of the world and the Russo-Ukrainian war. Given that food security is likely to remain an issue in 2023, the decline in food prices may take longer than expected. As such, any increase in commodity prices would only add fuel to the fire and is still an upside risk in the fight against inflation.

Forecast

The market predicts the Fed will hold interest rates steady or even start cutting them later in 2023. Economists say the Federal Reserve will cut its interest rate to a 25 basis point hike at its upcoming interest rate meeting.

Despite this, many Fed policymakers continue to comment that rates are likely to rise to more than 5%. This is contrary to what the market expects.

The widely anticipated quarter-point interest rate hike will raise the Fed's reference rate to a range of 4.5%-4.75%. Prices were close to zero last March.

Investors who trade the federal funds futures markets now expect the Fed benchmark rate cap to be 4.5% at the end of this year and 2.9% at the end of 2024.

Economic growth

In the last three months of 2022, the US economy grew by 2.9% compared to the same period last year. Growth was driven by increases in consumer spending, business investment, and government spending.

Consumer spending in the US also increased by 2.1% compared to the same period last year. This spending remained high as inflation began to fall. And the US job market remained tight.

Overall, for the full year, GDP grew by 2.1% compared to 2021. Despite an overall increase in 2022, the economy showed signs of cooling in the fourth quarter, declining slightly from 3.2% in the third quarter. Retail sales also fell in the last two months of 2022.

Recession?

However, the US economy is not clear. Solid growth in the October-December quarter will do little to change the widespread view among economists that a recession is very likely later this year.

Elevated lending rates and persistently high inflation are expected to gradually weaken consumer and corporate spending. In response, companies are likely to cut spending, which could lead to layoffs and higher unemployment. And a likely recession in the UK and slower growth in China will reduce the revenues and profits of US corporations. Such trends are expected to trigger a recession in the United States in the coming months.

Source: investing.com