What Will Happen With Inflation in 2023?

How Long is This Inflation Spike Going to Last?

There’s a new and different kind of inflationary shock coming to the market…

 And right now, I don’t think investors are properly prepared for it.

If you’ve been following us at DIYwealth lately, you’re already familiar with what caused the current high levels of global inflation, as well as what central banks are doing to control inflation and resume price stability.

I’ve discussed how central banks were undergoing “Quantitative Tightening” to shed assets from their balance sheets and, in so doing, decrease inflationary pressure on asset prices. And so much more.

If you’ve been paying attention to the stock market’s performance since then, you know this is going fairly poorly.

 In September, the Dow marked a new low for 2022. The S&P 500 is down tremendously. The tech-focused Nasdaq has fallen. And the tiny growth-stock focused Russell 1000 is down as well.

Even assets like gold and bonds and real estate are seeing falling prices, even though these are traditionally considered safe havens and hedges during recessions and high inflation periods.

It’s not often that every asset declines in tandem.

Some of this selloff has to do with declining valuations and deleveraging (meaning: financial institutions and investors are selling assets to clear debt obligations).

All of which is… technically good?

I mean, if you think about it, we want assets to not be in a bubble.

We want the world not to be saddled with so much debt.

If a temporary decline in asset prices is the cost of achieving that, then the 2022 selloff will ultimately prove to be good for long-term, buy-and-hold investors. Especially the ones who are continuing to buy and lower their cost basis.

What’s not good is inflation continuing to grow out of control and interest rates rising to combat it.

And politics might end up getting in the way of actually fixing this problem.

For example, the state government of California is going to pay out $1,050 to residents to “combat inflation.”

And at the national level, the U.S. government just approved the “Inflation Reduction Act,” which includes a slew of tax credits and payouts and infrastructure spending.

The spending on things like electric vehicle infrastructure and healthcare expansion goes into effect immediately, while many of the anticipated taxes and savings won’t have an impact for years.

Which means that the proposals in this bill are primarily inflationary before they become deflationary in 2027 or 2028.

At the same time, the U.S. Federal Reserve Bank is hiking rates faster and higher than any other point in the last 40 years.

Now, that might sound bad, but it’s by no means as extreme as what Turkey is doing.

Turkey’s inflation rate hit an astonishing 83% year-over-year.

Imagine buying something for $1,000 in 2021 and it now costs $1,830 in 2022. That’s how bad it is in Turkey right now.

One of the reasons it’s this bad is because, instead of doing what every central bank is doing and raising interest rates to crush consumer demand, Turkey is lowering interest rates.

You can see the dilemma that politicians and bankers are facing right now.

In the U.S. and Europe and the U.K., central bankers are battling policymakers to try to maintain price stability. They’re raising rates and selling off their assets to crush demand even as more and more money gets pumped into these economies by governments in the form of spending and tax cuts.

This will, in all likelihood, trigger a global economic recession.

On the other hand, you have anomalies like Turkey and Argentina that are willing to let inflation spread unchecked, like wildfire, until their currencies are practically worthless and no one can afford anything.

At times, the economic situation we’re in feels like a game where no one wins and everyone loses.  

How Long Will This Inflation Spike Last?

In August 2021, I shared with some of my paid readers some of the econometric work I had been doing and made a prediction about what level inflation we should be seeing by August 2022.

I made this prediction:

If we add another $1 trillion to the U.S. money supply by this time next year…

We can reasonably expect to see inflation go up about 9.2%.

In August 2021, the money supply in the United States was $20.6 trillion. In August 2022, it was about $21.6 trillion.

So the amount of money in the economy went up by close to $1 trillion, as I hypothesized it would.

The actual inflation rate was 8.5% in August 2022. Pretty close to my 9.2% prediction.

Over the summer, I’ve been refining the model, because I want to be able to give readers a sense of what level of inflation to expect next year — especially since it will massively affect investment performance in the coming months.

Here’s what I’m seeing:

On the low end, if the Fed manages to shed trillions of dollars from its balance sheet over the next year, the annual inflation rate will be around 0% to 1.3% by August 2023.

On the high end, if the U.S. economy simply sees money supply continue to increase at the same time the GDP contracts due to a recession, we will likely see a 4.5% inflation rate by July 2023 and a 3.4% inflation rate by August 2023.

This is relatively close to economist and consumer inflation expectations over the next year, which range from 4.8% to 6.22%.

But if you take a weighted average of these two scenarios…

You get a midline between these two extremes, which is my official prediction for what inflation will be in August 2023: between 2% and 3.2%.

This is relatively close to what the market is betting inflation will fall to over the next 5 years — 2.45%.

This prediction means inflation is likely to hover around 8% year-over-year for several months before it starts declining.

Why?

Simple arithmetic.

In the table below, I have the actual CPI inflation measure listed alongside what economists were predicting inflation would be at the time.

From the September reading, I created 5 scenarios: what would happen if the current CPI increased by 0% per month, 0.1% per month, 0.2% per month, 0.3% per month, and 0.4% per month.

The average monthly increase in inflation has been about 0.2% for decades.

But as you can see?

Even if inflation is bad and grows at an above average pace?

Inflation will still fall below expectations by September 2023.  

And it doesn’t matter if inflation is curbed by monetary policy or by a recession…

If inflation grows at an average or below average rate? We’re going to see inflation calm down and revert to normal by early- to mid-2023.

This is why I’m less and less worried about inflation…

But growing increasingly worried about what happens after the inflation we’re currently seeing.

And once we see what happens over the holiday season, we’ll have a better sense of what to expect in 2023.