Thoughts From Last Week 12-19-2022

Damon Walker, AIF | December 19, 2022

A message from Edge Investment Solution's Damon Walker:

As we enter the final stretch of the year, the U.S. economy is running on low gas against strong headwinds. Economic data this week showed a picture of declining industrial production, manufacturing and services PMIs and retail sales. Despite another cooler-than-expected inflation print, the Fed delivered hawkish messaging at its December FOMC meeting, downplaying recent progress on inflation and maintaining its higher-for-longer stance on monetary policy. In its updated Summary of Economic Projections, the Fed now sees inflation elevated for longer, growth cooling further and unemployment rising. The outlook laid out by the Fed is perplexing; both inflation and labor markets are showing clear signs of cooling, wage growth is softening and shelter inflation should peak early next year.

Notably, Chairman Powell has referenced core services ex-shelter inflation as failing to show signs of progress on multiple occasions. While this measure of PCE inflation is not produced by the BEA, we attempted to construct Powell’s series ourselves, as shown in the chart. Including inflation data for November and our own estimates of December, we see that core services ex-housing is indeed coming down. While it still remains elevated to historical trends, receding wage pressures, lower input costs and slowing aggregate demand should induce further declines in 2023. Investors were reminded to “not fight the Fed” after Powell’s speech with markets reversing gains from earlier in the week, and we heed this warning as well. Ultimately, it’s clear the committee is laser-focused on achieving 2% inflation and its emphasis on lagged inflation data means a Fed pivot may be further out than initially anticipated, narrowing the window for a soft landing further.

Source: BEA, J.P. Morgan Asset Management. *Series reflects a custom PCE price index of services excluding housing and gas and utilities. November and December figures are J.P. Morgan Asset Management estimates. Data are as of December 16, 2022.