E-piphany

This is a single issue, of the February 2023 Quarterly Inflation Outlook.

The QIO is a 15-20 page quarterly discussion of current topics in inflation, including underlying dynamics, valuation, and related markets.

Executive Summary

• We had expected that by now the peak in inflation would be in. However, the recent inflation data showed a new high in Median CPI and Core “Sticky” CPI for the cycle. Still, we believe the highs are imminent.
• The more important questions from here are, how far is inflation likely to recede? Will inflation volatility return to the prior levels, or remain high? Will the next inflation peak be higher or lower? And what will central banks do?
• We think median inflation will have difficulty declining beyond 4% for a couple of years. There is considerable ‘potential energy’ in the monetary system which will make a decline to the Fed’s target very difficult unless the money supply contracts more aggressively than it has so far. And we deem that unlikely.
• We think fixed-income volatility has entered into a new regime in which it will be persistently higher than we have been used to. The inflation curve should move higher, and become steeper over time.
• On the optimistic-note side, the Federal Reserve is showing signs that it is starting to focus on the problematic feedback loops. We are still not sure how they plan to fix that, but at least they’re focused on the right thing.
• On the other hand, policymakers in Japan are explicitly lobbying businesses to raise prices and persuading consumers that more inflation is a good thing. We are as negative on Japan as we have been in this century.
• Our point forecast for 2023 median inflation has been lowered to 4.9%; we initiate our 2024 forecast at 4.3% Median CPI.
• absolute basis for the first time in years. We believe that it is reasonable to accumulate them at yields in the high 1%, low 2% range.