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Thoughts From Last Week
As we illustrate in this week’s chart, the path to normalcy will be slow and could vary greatly depending on the economic backdrop.
On Friday, Federal Reserve Chairman Jerome Powell reiterated that inflation remains too high and that the central bank is determined to bring it back down to its 2% target, even if they must risk weakening the economy in the process. Chair Powell specifically noted that “reducing inflation will require a sustained period of below trend growth.” This tough talk comes just as we have begun to see an improvement on the inflation front. The July CPI report showed headline CPI remaining unchanged m/m and a notable deceleration in y/y growth. Looking ahead to the August report, declining gasoline prices and lower airline fares should provide additional relief, but the rest of 2022 could be mixed with natural gas prices rising and higher wages putting a floor underneath inflation. Nonetheless, we expect inflation will resume its decline in 2023, as weakening demand and improving supply chains ease price pressures. For the Fed, the key question is whether the current path to 2% inflation is quick enough; as we illustrate in this week’s chart, the path to normalcy will be slow and could vary greatly depending on the economic backdrop. Even in a scenario in which headline CPI grows at a consistent 0.2% m/m rate, the y/y growth figure would take a full 12 months to come down to just above 2%.
But what does all this mean for portfolios? If the Fed chooses to prioritize controlling inflation over economic growth, this would favor value over growth and international equities over U.S. equities. On the other hand, a more moderate pace of tightening could be a boost for U.S. equities and credit. In either situation, however, we do expect economic growth to slow; slower growth implies lower rates, which makes us increasingly comfortable in adding back some duration in portfolios.
Source: BLS, FactSet, J.P. Morgan Asset Management.