Despite encouraging data, CIO expects central banks to stick with a hawkish stance at present. (ddp)

This provides further evidence that the disruptions to supply chains that arose during the pandemic are continuing to clear. In the Eurozone, consumer price inflation releases have been surprisingly tame in Germany, France, and Spain. Most notably, German inflation slowed to 9.6% in the year to December, well below the 10.7% forecast by economists surveyed by Reuters.

The data has contributed to a positive start to equity markets in 2023, with the Euro Stoxx 50 gaining more than 4% at the time of the writing so far this week and the S&P 500 rising a more modest 0.4%.

But despite the encouraging data, we expect central banks to stick with a hawkish stance at present.

Inflation readings in the Eurozone were not all good news and core inflation remains high. German core inflation, excluding volatile food and energy prices, actually rose to 4.9% from 4.6%. The December reading was also flattered by a one-off government payment to help with household energy bills. And in Spain, while headline inflation in the year to December fell to its slowest pace in 2022 at 5.8%, core inflation rose to 6.9% from 6.3%in the prior month. Meanwhile, European Central Bank President Christine Lagarde has continued to stress that the fight against inflation has not yet been won, saying in an interview on 31 December that wages were probably rising “at a faster pace than expected.”

Rapid wage increases in the US raise the risk of more entrenched inflation. Monthly job openings data pointed to an employment market that is too tight for comfort, with vacancies declining only 54,000 to 10.458 million for November. Economists had expected a larger fall and the vacancy rate for October had also been revised higher. The data also showed that there remain 1.74 vacancies for every unemployed person in November, continuing to point to excessive demand for workers. That is likely to discourage Federal Reserve officials, who are eager to see a cooling labor market leading to lower wage rises. The three-month moving average of median wage growth for November was 6.4%, based on the Atlanta Fed’s Wage Growth Tracker. This is inconsistent with the Fed’s 2% inflation target.

The minutes of the Fed’s latest policy meeting underlined that further tightening lies ahead. The minutes of the December meeting, at which the Fed raised rates by 50 basis points, showed officials would need to see “substantially more evidence” of easing inflation. The Fed insisted that the slower pace of tightening in December, following four consecutive 75bps hikes, “was not an indication of any weakening of the committee’s resolve to achieve price stability.” Officials also warned that premature expectations of a dovish pivot by markets could “complicate the committee’s effort to restore price stability” by leading to an “unwarranted easing in financial conditions.”

We do expect an inflection point in inflation in 2023, for which more risk-tolerant investors can prepare. But with the fight against inflation still ongoing, we enter the year with a preference for defensive assets in both equity and fixed income markets.

Main contributors - Mark Haefele, Christopher Swann, Vincent Heaney, Patricia Lui, Jon Gordon

Content is a product of the Chief Investment Office (CIO).

Original report - Inflation cools, but too early to sound the all-clear, 5 January 2023.