2023 inflation outlook: Is there light at the end of the tunnel?

Russell Price – Chief Economist, Ameriprise Financial

As of Feb. 20, 2023

Inflation remains a top concern for U.S. households as the cost of living rose 8% in 2022, the strongest one-year gain since 1981, according to the Consumer Price Index (CPI).

In the past year, investors have had to contend with higher prices in their day-to-day life along with the negative impact of higher interest rates on the stock market and economy.

To put the current inflationary environment into perspective, Ameriprise Chief Economist Russell Price answers your top questions:

Interest rates are rising — why is it taking so long for inflation to subside?

Over the last year, the Federal Reserve has aggressively raised interest rates to weaken demand and quell price pressures.

These efforts have been effective in alleviating some price pressures, particularly for products that have also seen supply-chain improvements. But, as typically is the case with Fed rate hikes, the impact has been slow, and it will take more time for price trends to revert to acceptable levels.

Data shows progress is being made. Inflation subsided by the second half of 2022: After seeing a 41-year high of +9.0% in June 2022, the Consumer Price Index (CPI) slowed to +6.5% year-over-year in December.

Will inflation return to normal in 2023?

We are optimistic that further improvements in the inflation picture lie ahead. Inflation rates should continue to decline this year with notable improvements possible over the first half of the year, partly due to high year-ago comparisons. Consumers should not expect outright price declines for most goods and services but rather a deceleration in the pace of price increases.

The Federal Reserve typically targets an inflation rate of about 2% per year. While we don’t think that inflation will return to that level in 2023, we do expect a vast improvement over 2021 and 2022. By the end of 2023, we forecast CPI to be about 3% and the Fed’s preferred measure, the Core Personal Consumption Expenditure (PCE) Index, just under that, at about 2.6%.

How will inflation affect the markets in 2023?

Inflation is likely to remain a primary consideration for economic expectations and financial market activity this year, in our opinion. Recent improvement trends could lead the Fed to conclude its aggressive interest rate hiking cycle in the near-term. If so, we believe an end to interest rate hikes could benefit financial market sentiment.

Case in point: From March 2022 to the end of January 2023, Fed officials lifted their overnight lending rate from basically 0% to its current target range of 4.50% to 4.75%. The inflation spike — and resulting increase in interest rates – have been the key issues behind financial market performance and economic expectations of the last year. In 2022, the S&P 500 Index dipped 19.0% on a price-only basis and the Bloomberg Barclays US Aggregate Bond Index posted a 13% decline — its largest ever (bond prices decline as interest rates move higher).

Is the Fed likely to cut rates soon?

Unless inflation declines more broadly and at a faster-than-expected pace, we don’t expect a rate cut to come until the first half of 2024.

Are there any sectors where inflation is improving?

Prices for many goods, such as automobiles, furniture and appliances, have been dropping as demand for these products normalizes and supply chains resume ordinary functioning. However, many consumer services — driven by wage inflation — are still seeing rapid cost increases, according to the CPI report.

What inflation indicators should investors watch?

Fed officials have targeted wage inflation as a key influence in service-sector pricing. Most labor cost measures have shown wage increases to be easing but the job market remains tight and demand for labor is still high. As such, wage inflation could remain a lingering risk to the inflation picture over the intermediate term.

What could help lessen the impact of inflation on my investment portfolio?

Inflation is part of the broader financial landscape for investors, rather than a singular, dominant issue. As such, investors should avoid making major changes based solely on inflation.

That said, stock investments can often be good investments to hedge long-term inflation. Since 1871 stocks have historically outperformed inflation and have done so more consistently than other asset classes. Companies are typically able to increase their prices and pass on the costs of inflation to consumers during times of economic growth, which can lead to higher earnings and, in turn, the potential for higher stock prices and dividend income.