The Fed could deliver a golden 2023

The dramatic drop in US inflation has changed the playing field. So what will Fed chair Jerome Powell do?

Chair of the U.S. Federal Reserve Jerome Powell.

The dramatic, unexpected, now-sustained, and still unbelieved plunge in US inflation has utterly changed both the outlook for and the dynamics driving both the global economy and investments globally.

And changed them, if it’s not obvious, very definitely for the positive. And I mean very positive. Indeed – China and Russia, rather importantly aside – we could be heading for a ‘Golden 2023’.

I have to say ‘China and Russia aside’ because they are both impossible to sensibly compute; and they are big, very big.

China is all about Covid – does it really relax, does relaxing unleash Armageddon?

But this is overlaid over a more fundamental question about the China export-and-infrastructure growth model, which was already fraying before Covid.

Russia is of course about Ukraine – oil and gas supply and price, and so energy totally and globally – and about Vladimir and his finger ‘on the button’.

Again, all ‘incomputable’ in any rational far less predictive way.

So, China and Russia aside, overnight we get the huge, the potentially dramatic shift in 2023 drivers, with the Fed’s last interest rate decision for the year.

The inflation numbers have certainly buried any prospect of another 75-pointer. But then, as I have previously explained, 75-points was dead, buried and cremated some weeks ago.

More potently, the latest numbers don’t make even 50 points a ‘done deal’; they make the choice essentially between 50 points and 25 points – something, again, not countenanced a few weeks back by most and still not by many even now.

Indeed, I would personally not be surprised to see Fed head Jerome Powell go even further, and opt for a pause. The inflation numbers – properly understood in the context of the rate rises so far this year – make that an entirely valid option.

It is probably unlikely; it’s probably a sudden step too far.

More broadly, what Powell opts for – 50, 25 or indeed the pause – will ultimately be driven not by analytical precision but by the messaging and psychological massaging he wants to impart.

The package – the actual rate decision and the accompanying messaging is huge.

It is obviously critical for markets over the next few weeks.

But more broadly, more fundamentally and longer term – that’s to say, all through 2023 – it sets up a whole new dynamic between Wall St, the Fed, investment reality and what’s actually happening in the US economy.

I suggest that not only will it set up a series of positive feedback loops; but for once that positivity will be based on what looks like a low-inflation reality, and not as we have seen, pretty much since the 1990s, Wall St ‘demanding’ the Fed give it cheap money.

A month ago, when the last US inflation figures surfaced, I wrote that it was “entirely possible, maybe even probable, that a serious and sustainable slowdown in US inflation has been ‘hiding in plain sight’”.

To me there is now do doubt at all. Inflation in the US has all-but evaporated since midyear.

After a 1 per cent rise in prices in the US in the month of June alone; in the five months since, inflation in the US has added up to – and I stress, in total over the five months – just 1 per cent.

Commentators remain fixated on the 12-month figures, which fell – to most, ‘surprisingly’ – from 7.7 per cent to 7.1 per cent over the 12 months to November.

But that includes all the pre-July history, when global inflation was being spurred by three huge factors.

They were Russia’s invasion of Ukraine which sent oil and gas and food prices rocketing; the global Covid supply-chain disruptions; and the global surge out of 2021 lockdowns and Covid restrictions.

It was also when interest rates were still zero.

A very different future starts now.