According to Goldman Sachs, the Federal Reserve’s preferred measure of inflation will fall below 3% by the end of next year as supply constraints ease, the cost of housing declines and the labor market will cool.
Such an outcome could allow the Federal Reserve to be less aggressive in its cycle of raising interest rates as it strives to bring inflation back to its 2% target. Markets are very sensitive to the issue, with stocks and bonds rallying strongly late last week after consumer price data for October came in weaker than expected.
The S&P 500 SPX,
rose 5.9% last week, its best performance since late June. Nasdaq Composite COMP heavy technology,
soared 8.1%, its best weekly performance since March.
In a note released over the weekend, Goldman’s economic research team led by Jan Hatzius said the Core Price Consumer Expenditure Index, the gauge of price pressures that excludes items volatiles like food and energy which is closely watched by the US central bank, will fall from the current level of 5.1% to 3.5% by mid-2023 and could reach 2.9% by December .
“We expect core inflation to decline significantly in 2023 for three main reasons,” Goldman wrote. ” 1) a negative change in the contribution of property categories with limited supply, following the improvement of the supply chain, 2) a spike in housing categories reflecting a further rebound in vacant housing and a decreasing impulse of the reopening and return to cities, and 3) slowing wage growth, reflecting continued labor market rebalancing.
Inflation due to supply constraints currently adds 0.6 percentage points to the core PCE, but this will drop to minus 0.4 percentage points towards the end of next year, which is almost half of the slowdown in the overall base measurement.
“Supply chain disruptions and shipping congestion eased significantly in 2022, and car and consumer goods inventories rebounded from extremely depressed levels. is significantly improved, with automotive microchip shipments now outpacing 2019 by 42%. This has already catalyzed a 5% drop in the used car CPI, and we assume another 15% drop in 2023,” explained Goldman.
Housing inflation is set to peak this spring, Goldman estimates, as recent strong demand for rental properties has already triggered a surge in supply, with 1 million apartments under construction, the biggest pipeline since the mid-1970s. .
“Rental vacancy rates are starting to rebound as a result and are expected to return to pre-pandemic rates next year. Additionally, the boost provided by continued lease renewals at market rates now appears to be reflected into the monthly pace of housing inflation, as CPI microdata reveals that it already factors in an acceleration in renewal rental growth to 8% year-on-year. new leases has fallen sharply: we estimate only +3% annualized in the last quarter,” Goldman said.
Finally, a weaker labor market is expected to dampen wage growth and help reduce service-sector inflation by the end of 2023.
“Labour market rebalancing is already slowing wage growth, especially in sectors where the gap between jobs and workers has narrowed sharply, such as retail and leisure. We expect year-over-year wage growth to fall by 1.5 percentage points to 4% by the end of 2023, helping to slow inflation in service-intensive categories labor.
Goldman notes, however, that the market consensus is for core PCE to fall even lower to 2.7% by the end of 2023, but believes this is too optimistic as core services inflation will remain above 4%.
“This reflects a lower but still elevated pace of housing inflation later in the year, as well as an outright increase in health care inflation, partly reflecting the larger fee update. health insurance for at least 15 years”, concludes the bank.
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