Wells Fargo Forecasts Turbulence for Inflation and Possible Stock Rally Reversal

Summary

  • Wells Fargo strategists predict a troubled path to reach the Fed’s 2% inflation target, especially if the economic slowdown is not as severe as expected.
  • The bank also expects the effects of a gradual economic slowdown to be felt by 2024, due to tapering consumer spending support.
  • Key factors include dwindling pandemic cash reserves, rising credit delinquencies, increased credit reliance for purchases, and signs of consumer spending weakness from Q3 corporate earnings reports.
  • The strategists caution investors about a possible reversal of the 2023 stock rally.
  • Increased real interest rates in 2023 may add more strain to the economy, due to the deferred impact of Federal Reserve credit tightening.
  • Wells Fargo projects the Fed will maintain the federal funds rate within 5.25 – 5.50% until further economic deceleration imposes additional inflation pressure, avoiding early rate cuts which could spur higher inflation.
  • Despite these challenges, the bank’s strategists foresee key inflection points in both the economic cycle and Federal Reserve policy, suggesting a gradual economic slowdown may drive disinflation, setting the stage for rate reductions in mid-2024.

The Turbulent Path to Inflation Targets

Strategists at Wells Fargo foresee a bumpy road ahead for inflation to reach the Fed’s target of 2%, especially with a less sharp economic slowdown than anticipated.

Economic Slowdown and Consumer Spending

According to Wells Fargo, as 2023 comes to an end, an economic slump will evolve gradually. This comes as the buoyed consumer spending in early 2024 starts to taper off.

Factors Contributing to the Economic Scenario

Contributing to this scenario would be dwindling excess cash reserves from the pandemic across income quintiles, rising credit delinquencies, and increased credit dependency for sustainable purchases. Evidence of fragile consumer spending can also be seen in third quarter corporate earnings transcripts.

Implications for Stocks Rally

This anticipated situation does raise warnings about the 2023 stocks rally potentially reversing. As they noted, “Investors have anticipated a pivot to rate cuts by the Fed seven times since 2021, but stock rallies have reversed in the last six instances.”

Consequently, they add, “Hopeful developments throughout the majority of the year risk letting investors down in 2024, as the unfolding weaknesses become more apparent.”

Impact of Real Interest Rates

The sharp increase in real interest rates in 2023 is predicted to impose more economic pressure in the coming year, due to the delayed aftermath of Federal Reserve credit tightening.

Outlook for Future Actions by Fed

Forecasting for the Federal Reserve, Wells Fargo expects the central bank will retain the federal funds rate in the 5.25 – 5.50% range until an economic decline applies more strain on inflation, opting to circumvent early rate reductions that might risk higher inflation.

Anticipation of Key Changes

While these challenges may be daunting, the strategists foresee vital turning points in the economy and Federal Reserve policy. Due to a moderate economic slowdown, disinflation will increase and pave the way for rate reductions later in 2024. Increased market volatility can be anticipated due to the upcoming U.S. presidential election.

Endorsing caution, the strategists advise, “Given our economy’s base case, we recommend a more defensive portfolio management strategy, emphasizing quality equity and fixed-income positions and promoting patience until the commencement of a new economic cycle.”

In conclusion, the evolving economic conditions and projections by Wells Fargo could have significant implications for forex or trading. Investors may need to navigate carefully through potential shifts in the U.S. central bank’s policies, the economic slowdown, and rate decreases in 2024.

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