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U.S. – Inflation Peaking, but Watching the Fed

Guest Post by Ned Davis Research

Inflation peaking?

Our U.S. Inflation Timing Model has peaked, suggesting slower inflation in 2022. Easing supply chain issues and base effects also point to inflation moderating in the coming months. But improvement could stall if
rising geopolitical risks from the Russia/ Ukraine conflict could push up commodity prices.

Although the outcome of this geopolitical risk remains highly uncertain, an outright war could push up the price of commodities, many of which are already
in a tight position. Indeed, Russia is the world’s largest exporter of natural gas and wheat, each at nearly 20% of total world exports. The country also exports 10% of
the world’s copper and aluminum. Based on the latest correlations, some countries are more susceptible than others to higher commodity prices. In the commodity price arena (using the CRB index), the U.S. ranks first with the highest positive correlation with its CPI. Similarly, the U.S. CPI ranks one
of the highest (number two) when it comes to both oil and food prices.

Fed tightening cycles

The Fed will have a potentially difficult juggling act on its hands, as it needs to bring inflation down without sending the economy into recession or creating financial instability. The range of possible outcomes has kept financial markets on edge lately. Analyzing Fed tightening cycles since 1955, we find that economic growth slows more in fast than in slow cycles. 

Several broad conclusions stand out:

  • Economic growth does not slow precipitously at the start of tightening.
  • Fast tightening cycles are more detrimental to growth than slow ones (see chart above).
  • Interest rate sensitive sectors, such as manufacturing, housing, and autos, weaken
    faster than the aggregate economy.
  • The unemployment rate continues to decline in the first ten months of tightening but backs up after that.
  • The inflation record is mixed.
  • Recession begins a median of 25 months after the start of tightening.

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