According to Bank of America Securities, the U.S. economy will enter a phase of sustained disinflation, which will intensify over the remainder of 2023.
BofA affirms inflation is following a mean reversion trend, which is consistent with the fall in inflationary surprises since May 2022. The view is that a mild recession in the second half of the year and an ongoing deflation in goods should lead to a marked slowdown in overall inflation next year.
The U.S. economic team at BofA predicts that CPI inflation will fall to roughly 4% by the end of second quarter 2023, then converge to the Fed's 2% target by the end of 2024.
BofA's Predictions on the Fed Funds Rate and U.S. Treasury Yields: In terms of the Fed's next policy action, BofA anticipates an additional and final 25bps interest rate hike to 5%-5.25% in May. However, the Bank sees the first rate cut only after 10 months, in March 2024.
BofA anticipates 10-year Treasury yields at 3.25% by the end of 2023, based on a view of a modest recession in the second half of the year and lower inflation.
Under softer-landing scenarios for the U.S. economy, 10-year yields are expected to converge to their 3% equilibrium levels in late 2023 and early 2024.
Harder landing scenarios may drive yields toward the 1.25%-2.75% bottom half of the range, implying mid-2% yield levels.
Consensus Expects Stickier Inflation Ahead: If looking at how markets are pricing in inflation for the years ahead, it can be seen that BofA's disinflation call is currently out of consensus.
The five-year market-based inflation expectation gauge, commonly known as the breakeven rate, is currently at 2.3%, indicating investors expect inflation to average above the Fed's 2% goal in the next five years. The 10-year breakeven inflation rate is 2.25%, suggesting a quite sticky inflation outlook over the next decade. Both inflation expectations measures are above their 10-year average.
The iShares TIPS Bond ETF TIP provides exposure to inflation-protected U.S. Treasury government bonds with at least one year to maturity.
Read now: 5 Economists React to Core PCE Numbers: What Will The Fed Do Next?
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