Inflation finally moves lower. Will it last?

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Matt Toms

Matt Toms, CFA

Global Chief Investment Officer

Underlying data suggest that sizzling headline inflation will continue to cool

There is nothing the market hates more than uncertainty, and for a very long time, the US Federal Reserve mitigated investors’ fear of the unknown by answering every shock to the system with more “unprecedented and extraordinary” measures. Over time, these measures felt more like the norm than the exception.

That era is over. Inflation is the new measuring stick of macroeconomic risk and potential volatility. The market knows that the Fed must try to control inflation. What the market doesn’t know is whether the Fed will be successful.

As investors grapple with this new source of uncertainty, market expectations for inflation have been consistently below actual Consumer Price Index (CPI) data. In the chart below, the white diamonds represent the market’s forecast for inflation. The orange and blue lines represent the monthly CPI print. For most of the past year, the market thought inflation would cool, but each month it continued to run hot. Finally, in November, inflation came in below market expectations. The question now is: will the downward trend last?

The market has been anticipating lower inflation for months
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As of 10/31/22. Source: Bureau of Labor Statistics, Citi, Voya Investment Management.

We believe underlying data suggest that sizzling headline inflation will continue to cool. For example, the issues that have plagued the global supply chain since the pandemic are starting to abate, which means inventories are fully stocked. From a consumer’s perspective, 2021 was a year you wanted to do your holiday shopping early to make sure you could buy what you needed before the store ran out. This year, you can wait for discounts.

Job openings are moderating, and savings rates among consumers are starting to fall. This will have knock-on effects on prices, as companies will have less wiggle room to pass on higher costs to consumers. In addition, real-time rental price indicators suggest shelter prices are also starting to cool. And while food and energy prices remain stubbornly high, industrial metals prices, generally a leading indicator, have started to come down.

Importantly, while inflation has started to cool, the volatility we’ve seen from month to month in response to the CPI print will continue until a downward trend is firmly established and the Fed pauses its rate hikes. In the meantime, for long-term investors, we believe the current environment is a very compelling entry point from a risk/return perspective. Now that yields have reset higher, bonds are positioned to protect portfolios while delivering higher income.

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Past performance does not guarantee future results. This commentary has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities.

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