- Jim O’Sullivan says inflation is largely transitory and will recover by 2022.
- This means the Fed may not raise interest rates until 2023 but may start to taper their QE program.
- He adds that goods consumption has slowed while the services sector is picking up pace.
- See more stories on Insider’s business page.
The Consumer Price Index, which tracks how the prices of a broad variety of goods and services change over time, surged in June by 0.9% from May.
The increase was the highest since April 2008’s 1% rise, according to the Bureau of Labor Statistics.
While there’s no doubt inflation is on the rise, the real debate is centered around whether it’s transitory, says Jim O’Sullivan, the chief US macro strategist at TD Securities.
O’Sullivan is best known for his prescient views on the US economy, having won MarketWatch’s forecaster of the year award for 12 of the 15 years since it was created, including the last nine. He has also topped a similar Reuters list multiple times for his accurate forecasts of key US economic indicators.
In an interview with Insider, O’Sullivan shared his thoughts on US inflation, where the economy is headed, and what it means for investors.
“We’re of the view that this is largely transitory, as the Fed officials put it, and by the time we get into 2022, the numbers will be much more moderate,” O’Sullivan said.
O’Sullivan believes that the overall trend will remain tame and as a result, the
will be in no rush to start raising interest rates.
“I think the real threat to risk assets would be if the Feds had to aggressively raise interest rates,” O’Sullivan said. “And again, with inflation likely to be pretty tamed on a trend basis, we don’t anticipate the Fed actually raising interest rates until the end of 2023.”
In addition to looking at company valuations, quarterly earnings, and historic trends, O’Sullivan says interest rates — and how the Fed sets them — are key to how individual companies perform.
History suggests that higher inflation and interest rates would weigh on stocks, which are near all-time highs. Goldman Sachs strategists recently wrote that median, annual, and inflation-adjusted S&P 500 returns since 1960 were 15% when inflation was low, and 9% when prices were hot. Additionally, higher rates could diminish the excess returns that investors get by choosing stocks over a risk-free investment like Treasuries, or the so-called equity risk premium.
“To the extent that the Fed stays very accommodative and is very slow to raise interest rates, then that should be positive for the equity market,” O’Sullivan said.
However, O’Sullivan says he thinks the Fed will start tapering its quantitative easing (QE) program that included purchases of long-term securities to boost the economy.
The Fed initiated the program and cut interest rates during the 2008 Great Recession and again in 2020. The prior financial crisis was followed by the longest stock-
“Again, that’s not to say that the equity market can’t go up or down on any given day or depending on other factors besides interest rates. Of course, that happens,” O’Sullivan said.
Service industries over goods
As for sectors within the market, O’Sullivan believes that moving forward, some industries will do better than others.
“From a kind of GDP perspective, the way I look at it with consumer spending, there’s a lot more upside for services than goods at this point. I mean goods spending really soared during the pandemic with the help of stimulus payments,” he said.
Real goods consumption was up 15.9% in May from February 2020, Bureau of Economic Analysis data showed. That’s a surge O’Sullivan says was dramatic relative to real services consumption, which was down 4.2% for the same period.
“I think you look at the goods part of the economy, and I think that’s probably topping out for a bit,” O’Sullivan said. “We saw the retail sales report, which is mainly goods [showing] a big 11% surge month-over-month in March.”
O’Sullivan notes that was the same month the stimulus checks associated with Biden’s fiscal plan were released but since then, retail sales have flattened out.
He expects June’s retail sales report, which will be released later this week, to also be flat.
As the numbers in services industries continue to pick up sharply, O’Sullivan named air travel, hotel occupancy, movie theaters, and healthcare as four industries to keep close tabs on.
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