In congressional testimony in November 2021, Federal Reserve Chair Jerome Powell tried to walk back his earlier predictions that inflation would be “transitory.” Powell told lawmakers: “I think it’s probably a good time to retire that word.”

No kidding. Since Powell uttered those words, inflation has come down but remains far stickier than expected.

In February, we got data for the consumer price and producer price indices, and the personal consumption expenditures (PCE) price index, for the month of January. The numbers made a mockery of the word “transitory.” All three yardsticks came in hotter than estimates, stunning Wall Street and sending stocks down.

To fight inflation, and perhaps to save face, Jerome Powell is likely to push a hawkish policy further into 2023 than Wall Street had hoped. The markets aren’t all about algorithms; they’re also made up of human beings with emotions. Will Powell’s ego prompt him to go too far?

The next meeting of the Fed’s policy-making Federal Open Market Committee (FOMC) is scheduled for March 22, and expectations are for the FOMC to raise rates by 0.25%, bringing the fed funds rate to about 5.0%.

The next few weeks will prove pivotal for the stock market. On March 14, the U.S. consumer price index (CPI) inflation data for February will be released. The month’s CPI is projected to come in lower than last month’s figures, with headline CPI expected to be 5.9% year-over-year, and “core” CPI (excluding volatile food and energy components) expected to fall to 5.4%.

The Fed seems to be nearing the end of its rate-tightening cycle, with two or three additional rate hikes of 0.25% probably in the cards. But this month, if the inflation numbers for February come in hotter-than-expected, all bets are off.

Hovering over monetary policy is the ghost of Powell’s infamously hawkish predecessor, Paul Volcker. The implicit challenge is for Powell to be as “tough” as Volcker in fighting inflation. But this need to show toughness could push the economy into recession.

Keep in mind, inflation is largely the result of supply imbalances and disruptions caused by the pandemic and Russia-Ukraine war. Interest rate policy has no power over those problems, although it can make a difference by crushing the economy.

Inflation on their minds…

It’s good news that several key inflation indicators (e.g., shipping costs, cargo backlogs, and housing prices) are falling. It’s also clear that inflation has peaked and will decline throughout 2023.

But inflation still preys on the minds in the corporate C-suite. Higher input costs are squeezing net profit margins and weighing on bottom lines. Companies with pricing power are bumping up against the limits of their flexibility.

Research firm FactSet recently searched for the term “inflation” in the conference call transcripts of all the S&P 500 companies that conducted earnings conference calls from December 15 through February 23.

Among these companies, 325 have cited the term “inflation” during their earnings calls for the fourth quarter. This number is above the five-year average of 201 and above the 10-year average of 157 (see the following chart).

February 2023 is officially in the history books and it was a dispiriting month for investors. For the month, the Dow Jones Industrial Average fell 4.2%, the S&P 500 shed 2.6%. and the tech-heavy NASDAQ declined 1.1%.

Stocks slumped in February due to stickier-than-expected inflation and a concomitant rise in Treasury yields. On Wednesday, the main U.S. stock market indices closed mixed as follows:

• DJIA: +0.02%
• S&P 500: -0.47%
• NASDAQ: -0.66%
• Russell 2000: +0.08%

Manufacturing data released by China on Wednesday pointed to a strong economic rebound in February in that country, which stoked global inflation fears and spooked Wall Street. China’s PMI last month rose to 51.6 from January’s 49.2, the fastest rate of growth in a decade.

Beijing’s abandonment of its deeply unpopular and economically damaging COVID restrictions has done the charm for growth, but makes the fight against inflation even more problematic.

Earnings deceleration…

Inflation, unfortunately, remains the big story. But corporate earnings are another worry. Fourth-quarter corporate earnings season has concluded, with downward revisions continuing.

About 96% of companies have reported Q4 earnings so far. Among these companies, about 69% have reported a positive earnings surprise, well below the five-year average of 77%, according to FactSet.

These positive earnings surprises have exceeded expectations by about 1.1%, below the five-year average of 8.6%. Overall, earnings growth in Q4 is projected to post a year-over-year decline of -4.9%.

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John Persinos is the editorial director of Investing Daily.

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