Even as U.S. inflation climbs, Wall Street sees steep fall coming

Many Wall Street economists are holding firm to their bet that U.S. inflation will slow substantially over the next year even as they’re being forced to keep raising their predictions for coming months.

With most having shared the Federal Reserve’s failure to predict the stubbornness of last year’s price pressures, economists continue to be surprised by how much inflation is spreading through the economy. That was laid bare by last week’s core consumer price index for September, which beat the expectations of most forecasters by jumping to a 40-year high of 6.6%.

But even before that release, economists had boosted their inflation projections for the next few quarters. Despite that, many still see repeated interest-rate hikes from the Fed eventually closing much of the gap with the central bank’s 2% goal by 2024.

“I think everyone’s working backwards and saying, let’s take the Fed at their word that they’re resolved to bring inflation down,” said Andrew Hollenhorst, chief U.S. economist at Citigroup Inc. Without projections that higher rates will stifle economic growth and boost unemployment, “then there wouldn’t be this expectation that inflation would move lower.”

According to the latest Bloomberg monthly survey of economists, the core personal consumption expenditures price index — which the central bank counts as a preferred inflation gauge — will show an average annual increase of 2.8% in the fourth quarter of next year and 2.6% in the first quarter of 2024. The survey was conducted before the latest CPI report.

The Fed’s own forecasts paint a similar picture. They expect a median core PCE price index of 3.1% in 2023 and 2.3% in 2024, according to their latest projections from the September meeting. At the same time, they now see the price measure that excludes food and energy at 4.5% this year, up from a 4.3% projection in June.

However, some economists have their doubts.

Stephen Stanley, chief economist at Amherst Pierpont Securities LLC, thinks “we’d be lucky” to get core CPI to fall to 4% year-over-year by the end of next year. He said the composition of inflation is concerning, noting how the “the most persistent categories that are the ones that seem to be driving things right now.”

Eventually the Fed will tighten enough to cool the labor market, he said. “But boy, it feels like we’ve got a ways to go to get there.”

There are some welcome signs that goods prices are cooling. Supply networks continue to improve and high interest rates are seen weighing on demand throughout the economy.

Housing Impact

The housing market presents the clearest evidence so far that the Fed’s policies are working their way through the economy. Mortgage rates have skyrocketed to the highest in 20 years, sapping demand that’s starting to filter through to slower home-price growth.

Meanwhile, retail sales were flat in September, and receipts at building materials outlets dropped 0.4% after robust gains in the prior two months, underscoring the impact of higher borrowing costs.

“Momentum is slowing as economic uncertainty rises, and lower prices may have helped restrain select categories as retail inventories climb,” Bloomberg economist Andrew Husby said in a note Friday.

On the flip side, the very reasons that have made inflation stubbornly high aren’t all going away.

Housing costs, for one, tend to filter through to official price measures with a lag. Bloomberg Economics doesn’t expect the key shelter components to peak until next year. Food prices aren’t abating either, especially as Russia’s war in Ukraine impedes key exports like wheat.

Gasoline prices, which dropped throughout the summer and contributed to slower inflation readings, have since climbed. The cost of diesel, used for truck transportation of freight, is also on the rise.

“We expect inflation to be somewhat slower to recede, given the ongoing strength in services and the rebound in gasoline prices,” Wells Fargo & Co. economists said in a note Friday. “But we are growing more confident that the trend in core inflation is downward.”

Brett Ryan, senior US economist at Deutsche Bank AG, also expects inflation to moderate notably by the end of next year, with core PCE falling to 3.5%, amid rising unemployment and a recession.

But when it comes to inflation, “it’s consistently been upside surprises though, so I think the risks certainly remain that it remains stickier for longer.”