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4 Reasons 2022 Inflation Spike Won’t Kill U.S. Economy

By Julian Hebron, The Basis Point 

There are only two other times in modern history when consumers have been more financially anxious than they are now, and inflation is their main worry as the second quarter kicks off. This begs the question: will the 2022 inflation spike kill the economy for consumers? Short answer: no.  

Consumer Financial Anxiety Requires Education  

Thirty-two percent of Americans worry that inflation will hurt their finances in 2022, according to the University of Michigan consumer sentiment index. Consumer sentiment was only worse in two other periods: the March 1979 to 1981 recession and the peak of the global financial crisis in 2008. 

Financial headlines can be confusing to consumers. Headlines are louder, more frequent, and less informed in the social era. Still, we can’t dismiss how consumers feel about their financial prospects. Instead, we must educate them, and below is a four-part strategy.  

The 2022 Inflation Spike Drops by 2023 

Here’s the basic cycle of consumer sentiment right now:  

  1. Consumers are ignited by headlines of rising prices for gas and essential items. 
  1. Politicians fuel this fire and fear by blaming it on other politicians.  
  1. It becomes a populist tire fire when famous rappers joke how they were robbed at the gas station

Worry is warranted if inflation was expected long term, but it’s not. Here’s the inflation outlook that most headlines skip: 

  • Today, annualized CPI inflation is 7.9%. Goldman Sachs expects this will cool to 5.6% by year-end 2022 and to 2.8% by year-end 2023. Wells Fargo expects this will be a similar 7.5% by year-end 2022 and cool to 2.6% by year-end 2023. 
  • CPI inflation gets all the headlines but has less influence on the Fed, which prefers PCE inflation because it tracks more goods people buy, and does a better job tracking how people adjust spending when prices change. 
  • Today, annualized Core PCE – the inflation measure that most influences Fed rate policy – is 5.4%. Goldman predicts this will cool to 3.9% by year-end 2022 and to 2.4% by year-end 2023. Wells Fargo expects this will cool to 4.9% by year-end 2022 and cool to 3.0% by year-end 2023. 
  • If this happens, inflation could normalize much sooner than anxious consumers think. 

Fed Inflation Fighting Playbook in 2022 

To bring inflation down to these estimated 2023 levels, the Fed has begun raising short-term bank-to-bank lending rates. In late-March 2022, The Daily Shot summarized this Fed playbook well, noting:   

“Eight 25 bps hikes are now fully priced in (nine including the one this month). Of course, there aren’t eight additional Federal Open Market Committee (FOMC) meetings this year, which means we will get a few 50 bps hikes along the way.” 

That the targeted Fed Funds Rate has been 0.25% since COVID hit the U.S. two years ago. The March 16, 2022 rate hike, noted above, brought that rate up to 0.5%.  

The Fed had also been buying mortgage bonds to keep rates low since 2009. It ended that buying in the first quarter of this year. 

Near-zero rates and years of bond buying have supported consumers, and businesses, well through a post-financial crisis economy plus a pandemic. 

2Q22 Mortgage Rate Spike is Early Reaction to Fed Playbook 

But reversing this stimulus is jarring at first. By “fully priced in,” the note above means bond markets have already reacted strongly to Fed moves.  

For example, mortgage rates have risen almost 2% in 2022 – from low-3% in December to around 5% now.  

Mortgage rates rise when bond prices drop in a selloff, and bonds have sold off in 1Q22 as investors see less Fed bond stimulus and more Fed rate hikes. 

Bond investors also hate inflation because it erodes future returns, so this has also contributed to bonds selling and rates rising. 

But if lower inflation outlooks for 2023 hold true, this 2022 rate spike may moderate. 

About That Inverted Yield Curve & Recession 

Another anxiety-producing narrative is about an inverted yield curve leading to recession. It goes like this:  

  • The Fed hikes overnight bank-to-bank rates from 0.25% early-2022 to 2.75% early-2023. 
  • This causes 2 Year Note yields to spike more (now near 2.29%). 
  • This could make 2 Year Note yields higher than 10 Year Note yields (now near 2.34%).  
  • Inverted yield curves where short rates exceed long rates often signal recessions.  

This is a valid narrative, and it’s definitely fueling headline fires right now.  

But most economic growth outlooks peg inflation-adjusted GDP at around 3% for 2022 and 2.5% for 2023.   

This GDP growth is in line with pre-pandemic years, and while 2023 GDP growth projections decrease, a recession is when inflation-adjusted GDP goes negative, and no major projections call for that. 

2022 Inflation Won’t Kill the Economy 

It’s unsurprising consumers are frightened by today’s headline inflation figures. We can expect politicians to stoke inflation fears more in 2022. And who’s not going to click on inflation jokes from clever celebrities? 

But I hope the four themes and supporting data above help you cool things down for your customers and team members. You can be sure I’ll be watching that consumer sentiment figure for you as this plays out.  

These datasets are updated all the time, so you can follow along at The Basis Point.