The Fed Chair’s acknowledgement that economic pain may be required to bring down inflation stands in marked contrast to prior rosy projections of a soft landing. While inflation may have indeed peaked, we remind investors that peak inflation is not necessarily low inflation. Inflation may have come off from the historical highs reached this year, but it is still a long way from the Fed’s 2% target. While the broad commodity complex has declined, sticky inflation components such as wages and rents have proved to be far more persistent. The possibility of a wage-price spiral in the US has become a very real scenario. Although inflation expectations have remained relatively anchored compared to the 1970s when Paul Volcker had to raise interest rates to 20%, we find it difficult to envision inflation smoothly falling back to the Fed’s target of 2% when the Employment Cost Index is at 5.1% and Owner’s Equivalent Rent is at 5.8%. Our base case is that it is likely to take a recession in order to restore price stability. We highlight that double digit rallies were common in previous bear markets and would recommend investors to sell any rally in risk assets before we can see a sustainable drop in inflation to acceptable levels.

We discuss our outlook and the factors we see as key to drive markets going forward below :