Schwab Market Perspective: Why 2022 May Be a Better Year

As 2021 draws to a close, there are signs that the new year may be better than the last. The direction of COVID-19 variants remains difficult to predict, but another recent fear that has bedeviled the markets—inflation—may be about to ease. Treasury bond markets are sending a message that the Federal Reserve may not have as much scope to raise short-term rates as its forecasts suggest, and Congress has reached a deal that postpones the debt ceiling issue until 2023.

U.S. stocks and economy: Pressures may be easing

As 2022 approaches, investors are looking forward to a potential easing in the pressures that muddied the economic outlook during 2021, including inflation. While consumers haven’t yet reined in their spending—U.S. retail sales increased by 0.3% in November, the fourth monthly increase in a row—the proportion of consumers planning to make major purchases over the next six months remains depressed.1

Much of the souring in buying sentiment is due to the broad increase in inflation this year. As you can see in the chart below, not only has the Consumer Price Index (CPI) increased at a 6.8% annual rate—the fastest since 1982—but the CPI components associated with the economic reopening after COVID-19, such as car prices and airfare, have become bigger contributors to overall inflation after seeing their impact wane throughout the summer.

Return of the “reopening” components

In the second quarter of the year, reopening components’ prices surged mostly due to supply-related bottlenecks; thus, their resurgence suggests that we are not yet out of the woods with kinks in the global supply chain.

Fears about higher and persistent inflation have been well telegraphed by consumers, but some market measures have adopted a more sanguine tone. As shown in the chart below, the 5-year, 5-year U.S. dollar inflation swap rate—which measures the expected average inflation rate over the five-year period that begins five years from today—has moved lower from its recent high of 2.6%. Another measure, from the University of Michigan, implies that consumers expect inflation to settle at 3% over the same time frame—markedly lower than the current rate of 6.8%.