Inflation and Recession

US inflation has steadily cooled since mid-2022, thanks to large interest-rate increases by the Federal Reserve.However, a four-month drop in the dollar is threatening to derail that trend by raising the cost of imported goods.The dollar index has fallen by more than 11% from a peak reached in late September.

2022 marked a year where financial markets were challenged by an aggressive and synchronised monetary policy tightening. Russia's invasion in Ukraine fuelled geopolitical tensions and higher energy prices.

China’s transition towards ‘living with Covid-19’ is happening faster than local health experts anticipated when the phased easing of restrictions started in November. It brings forward the onset of a recovery phase to as early as March. The number of infections peaked in January, based on Peking University estimates. The consequent higher immunity levels among the general population mean that secondary waves should have a lesser hit in terms of the number of severe cases, as was the experience elsewhere.

Do Malaysians really understand what is happening with inflation, beyond the pain inflicted by rising prices?

As 2023 gets underway, so do the central bank meetings and the Bank of Canada will be the next after the BoJ to announce its first policy decision of the year. Meanwhile, investors will be nervously awaiting the first PMI readings of 2023 next week as they juggle to reach a consensus about the recessionary risks. In the United States, there will additionally be the advance GDP estimates for the final quarter of 2022, as well as PCE inflation data. The latest CPI numbers will be at the forefront too in Australia and New Zealand. 

Amid speculation that the US could be slipping into a recession, upcoming flash PMI data will be eagerly assessed to gauge the business climate in the opening month of the year. The surveys from S&P Global have been sending especially weak signals for output and demand growth, albeit with labour markets remaining relatively resilient, which has in turn led to a marked cooling of inflationary pressures. Putting all of the signals together will provide insights into the potential future path of monetary policy.

For the past year the euro area has been touted for a severe recession during 2023. Up to now, data have failed to follow suit as they enjoy a period of better-than-expected prints. This situation could reflect the extreme pessimism among professional forecasters going into 2023, but it is evidently unsettling the market and causing a wave of upward revisions in the EURUSD projections. Having said that, next week’s economic releases would be the first real test on the current shape of the euro area economies.

This week’s data was broadly supportive of confidence, with the risks around inflation and therefore the policy outlook thought to have improved into the new year.

Retail sales edged lower by 0.1% month-on-month (m/m) in November, a better outturn than Statistics Canada’s advance estimate for a 0.5% drop. Adjusting for the impact of inflation, the volume of sales was down 0.4% on the month.

If the Federal Reserve is to ease U.S. monetary policy this year, it may be a backdoor loosening around its quantitative tightening channel rather than lower interest rates.