For over a year, sky-high inflation has forced households to stretch their dollars to make ends meet. While you may know how inflation impacts your personal budget, it’s more challenging for experts to determine how a sustained period of high inflation will impact the stock market.
One metric to consider is the International Monetary Fund’s inflation forecast. With inflation numbers starting to cool off in 2023, the IMF’s latest forecast suggests a recovery is coming, though how soon (and how smoothly) it will happen, we can’t say. This report has important implications for investors, so keep reading to learn what it could mean for you.
- High inflation can have negative impacts on households, businesses, and investors.
- Typically, high inflation leads to more volatility in the stock market.
- The latest IMF inflation forecast paints a mixed picture of economic recovery across the next several years.
What is the IMF Inflation Forecast?
Formed in 1944, the International Monetary Fund (IMF) is a global organization with the goal of building a framework for international economic cooperation. According to the organization’s website, the IMF works to achieve sustainable growth and prosperity by “supporting economic policies that promote financial stability and monetary cooperation.”
One of the organization’s many contributions toward this goal is the quarterly World Economic Outlook report. Many investors carefully consider the forecasts and other information included in this report because it can potentially illuminate economic dangers ahead.
Current IMF Inflation Forecast
The most recent installment, titled A Rocky Recovery, was published in April 2023. Within the report, the IMF included its global inflation predictions for the next couple of years. Here’s a closer look at the forecast:
- 2022: The global inflation forecast showed inflation hitting 8.7% in 2022, up from 4.7% in 2021.
- 2023: Global inflation is forecast to decline to 7.0% in 2023.
- 2024: Global inflation is forecast to decline to 4.9% in 2024.
The IMF predicts global inflation will not return to its target rate until 2025. Even with lower commodity prices, core inflation is taking longer to decline.
In addition to these inflation predictions, the report included global growth predictions. Here’s the breakdown of those growth predictions:
- 2023: The global growth forecast expects growth to bottom out at 2.8% in 2023, down from 3.4% in 2022.
- 2024: The global growth forecast expects growth to split the difference in 2024, settling at 3.0%.
In their October report from last year, the IMF noted that its growth predictions were the weakest they’d shared since 2001, ignoring the global financial crisis and the beginning phase of the COVID-19 pandemic. With that in mind, the language of the latest World Economic Outlook report is more encouraging.
The report says, “On the surface, the global economy appears poised for a gradual recovery from the powerful blows of the pandemic and of Russia’s unprovoked war on Ukraine. China is rebounding strongly following the reopening of its economy. Supply-chain disruptions are unwinding, while the dislocations to energy and food markets caused by the war are receding.”
Other Insights from the Report
The IMF wrote extensively in their latest report about recent troubles in the financial sector. There was an extended period of low interest rates before last year’s sudden tightening of monetary policy. The IMF warned repeatedly that such a rapid increase in rates would have serious repercussions for economies worldwide.
The report says, “The financial instability last fall in the gilt market in the United Kingdom and the recent banking turbulence in the United States with the collapse of a few regional banks illustrate that significant vulnerabilities exist both among banks and nonbank financial institutions.”
Interestingly, the report suggests the slowdown in growth is mostly concentrated in advanced economies. The IMF provided two different growth rate predictions – one global prediction and one for advanced economies. Whereas the baseline prediction suggested growth would slow from 3.4% in 2022 to 2.8% in 2023, advanced economies are predicted to see growth slow from 2.7% in 2022 to 1.3% in 2023.
The report explains, “At this point in the tightening cycle, we would expect to see stronger signs of output and employment softening. Instead, both output and inflation estimates have been revised upward for the past two quarters, suggesting stronger-than-expected demand, which may require monetary policy to tighten further or to stay tighter for longer.”
Considering the strain we’ve recently seen in the financial sector, the IMF says we’re entering a “perilous” era in which growth is slowing but inflation has yet to turn a corner and drop decisively. The IMF suggests policymakers must be especially careful as they attempt to manage inflation without pushing economies into a recession.
What Inflation Means for Stock Market Investors
When building a portfolio of stocks, inflation is one important factor to keep an eye on. Inflation impacts the cost of living by decreasing the purchasing power of a currency. Although experts consider some level of inflation a good thing, too much inflation can quickly turn into a bad thing.
Here are a few ways that high inflation can impact the economy at large, and in turn, stock market investors:
Falling purchasing power for households
The pressure of inflation on household budgets tends to mean that consumers cut back on spending. With a drop in consumer spending, the stock market often feels a negative impact because the underlying company books aren’t doing as well as they once were.
With consumers spending less, real returns for stock market investors tend to drop.
Additionally, consumers tend to focus their spending on goods and services that they can’t live without. For example, households might spend most of their budget on essentials like food, housing, and gasoline. With that, value stocks of companies that provide these types of goods to consumers tend to do better than growth stocks during a period of high inflation.
The Fed combats inflation with higher interest rates
The Federal Reserve considers inflation when implementing monetary policy. The institution aims for a target inflation rate of 2% over the long term. If the inflation rate gets too high, the Federal Reserve will hike interest rates.
As of May 2023, we’ve seen the Federal Reserve increase the federal funds rate ten consecutive times in an effort to tamp down inflation. As interest rates rise, that’s one factor slowing down economic activity.
A higher federal funds rate influences the rate at which banks borrow and lend money to each other overnight. Banks must meet reserve requirements related to how much cash they keep on hand, so a higher fed funds rate encourages banks to save more and lend less money to consumers.
The cost of short-term borrowing increases with a higher fed funds rate, as do variable interest rates on things like credit cards. Banks will also raise yields on products like savings accounts to encourage consumers to deposit more money with them.
Inflation tends to mean more volatility in the stock market
When inflation is too high, it is a real threat to the financial fabric of society. After all, households lose increasingly more purchasing power, which can lead to large-scale issues.
As companies and consumers adapt to the changing economic conditions, the stock market tends to be more volatile. On top of this uncomfortable level of volatility, in the past, stock market investors have seen lower real returns during periods of high inflation.
Another by-product of high inflation is a higher unemployment rate, as companies attempt to cut costs by shedding inessential employees. This can lead to further economic pain, decreased spending power for unemployed people, and less money entering the economy overall.
How to Invest with Inflation Running Wild
With inflation wreaking havoc on budgets across the nation, it’s expected that the stock market will experience some turbulence. During this economic period, the focus on monetary policy tends to be getting inflation under control. But in the meantime, companies must adapt to the new market conditions.
As an investor, it can be a challenge to sort out which companies are doing better than others. Although most investors tend to favor value stocks during periods of high inflation, growth stocks may eventually make an impressive rebound. Additionally, many investors tend to focus on commodities, precious metals, and Treasury Inflation-Protected Securities (TIPS).
But building a portfolio that balances your long-term priorities with the current threats of inflation can be time-consuming if you do it alone.
With AI investing products becoming more accessible, it may be worth your time to consider using a service that helps you invest defensively. Tracking reports like the World Economic Outlook report and the monthly Consumer Price Index report is another way to guide your investing strategy.
The Bottom Line
The latest World Economic Outlook report from the Internation Monetary Fund (IMF) suggests inflation will continue to decrease over the next year, returning to its target rate sometime in 2025. The IMF predicts global growth will drop below 3.0% this year.
High inflation is one of many issues companies are currently facing. Although inflation is one major factor, it’s not the only indicator of a company’s potential growth. Many companies struggle during times of inflation. But some will continue to thrive, even in less-than-ideal economic circumstances.