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Recent weeks have introduced significant questions as to whether the latest inflation outlook warrants recent optimism. Revisions to 2022 inflation data and hotter-than-expected releases to start the year have accompanied a blockbuster payroll report for January and strong consumer spending data. These data have many now contemplating a “no landing” scenario (in other words, not only avoidance of a recession in 2023 or early 2024, but continued strength in the economy). We do not share this optimism. In our view, persistently hot inflation and economic data will lead to higher rates than markets currently forecast. In turn, this may increase the chance of recession, albeit over an extended timeframe than first expected. 

The Fed’s conundrum

February produced several key inflation updates that together form a more challenging backdrop for the Fed than was understood in January. On February 10, the Bureau of Labor Statistics updated its seasonal adjustments for the Consumer Price Index (CPI), resulting in upward revisions to core CPI (excluding the volatile food and energy prices) in the second half of 2022. Then January’s Producer Price Index (PPI), CPI, and Personal Consumption Expenditures Index (PCE) inflation all moved higher from the prior month, signaling that inflation could prove stickier. Markets have repriced expectations for the fed funds rate—in particular, raising the peak rate to 5.4% and removing any expectation for rate cuts in 2023—and markets have cooled. Stubborn inflation due to supply-side forces is central to our 2023 Capital Markets Forecast

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