When Will the Fed Brake?

The inflation puzzle still seems far from being solved. The Federal Reserve is confronting mixed data showing price gains may be slowing, but average hourly earnings are still climbing in defiance of the central bank's many efforts to tamp down the economy. The market, meanwhile, appears to have a more optimistic view of the Fed's powers. Despite the central bank's consistent messaging that it plans to "hike and hold" throughout 2023, the futures market is pricing in rate cuts late in the year.

For their part, central banks abroad are slowing their rate hikes and international stock markets have responded positively. The MSCI Euro Index, which tracks the stock market performance of companies based in the eurozone, has delivered its best performance since the late 1990s so far this quarter.

U.S. stocks and economy: Fed in the middle

As we turn to 2023, the story for the U.S. economy will likely shift focus from inflationary concerns to potential stresses in the broader economy and labor market.

To be sure, inflation is still high in relative historical terms, even if rates are slowing. And wage growth is proving too stubborn for a Fed keen on holding down inflation expectations. Average hourly earnings grew 5.1% from a year earlier in November, according to the most recent jobs report, and the annualized gain over the prior three months (which is a better gauge of the near-term trend) was the fastest since January.

The Atlanta Federal Reserve bank's wage growth tracker corroborated the trend, showing headline growth of 6.4% in November, with both job switchers and job stayers seeing gains, as shown in the chart below.