CPI Snapshot: What Will It Take to Satisfy the Fed?

CPI Snapshot: What Will It Take to Satisfy the Fed?

Wall Street economists expect Tuesday morning’s consumer price index release for August to show a monthly decline of 0.1%, helped by falling gasoline prices . This would bring the CPI inflation rate down to 8% from 8.5%. But the outlook for Federal Reserve and Dow Jones policy depends on what happens with core inflation, which excludes volatility in food and energy prices. Core CPI is expected to rise 0.3% over the month, bringing the annual core inflation rate to 6.1% from 5.9%.




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A weaker-than-expected reading of core inflation could reduce the odds that the Fed will back a third straight 75 basis point rate hike on Sept. 21. Since Monday afternoon, the financial markets have assessed the chances of another jumbo-sized move at 92%. These overwhelming odds suggest it would take an incredibly weak inflation reading to put a 50 basis point move into play.

A subdued inflation report, however, could bolster expectations that the pace of Fed rate hikes will slow after September.

The Fed is focusing on core inflation

“Underlying inflation is a better predictor of inflation,” Fed Chief Jerome Powell said at his July 27 press conference.

In previous months, when oil and gas prices soared, the Fed focused on headline inflation. But now that gas prices are falling, the Fed’s tone has changed. Core prices are back in focus again, which is a return to normal.

Usually, Powell explained, policymakers can deal with a short-term rise in commodity prices like oil. But inflation has been too high for too long, so there is an increased risk that households will start to expect higher inflation in the future. This can lead to behavioral changes, such as more aggressive bargaining for higher wages and increased spending – before prices rise further.

In other words, headline inflation only matters when it’s bad for an extended period, like the first half of 2022. So if oil prices start to rise again, attention might again to change.

The core CPI, which covers 77.4% of the household budget, includes goods other than food and energy. It also includes non-energy services, such as rent, medical services, transport and education. These services represent 56% of household expenditure.


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Goods Vs. Services Expenses

Recently, inflation in major goods categories has been on a downward trend, falling to 7% in July from a peak of 12.3% in February. The decline in goods inflation came as supply chain issues were ironed out, high prices dampened demand and consumers shifted more spending towards services, reversing the effects of the pandemic. .

“Real spending on goods has fallen slightly in each of the past two quarters,” Fed Vice Chairman Lael Brainard said last week.

Retailers love walmart (WMT) and Target (TGT) cut prices after finding themselves with too much inventory.

However, inflation in the prices of non-energy services has not yet calmed down, up 0.4% in July and 5.5% compared to a year ago. The annual increase was the June high in 30 years.


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Until inflation starts to recede for this category of spending, the Fed may not be convinced that inflationary pressures are easing. Indeed, price increases for these services are closely linked to the tight labor market and strong wage growth. If wages did not increase by more than 5%, sharp price increases would hurt demand and balance the markets.

The August jobs report found some improvement in labor force participation, bringing the unemployment rate to 3.7%, despite solid employment growth. The same could start to ease wage pressures, but for now the labor market remains far too tight for the Fed.

Dow Jones advances ahead of CPI report

On Monday, the Dow Jones Industrial Average climbed 0.7%, building on last week’s rally. The S&P 500 rose 1.1% and the Nasdaq composite 1.3%.

Stocks are trying to defend themselves after Fed Chief Powell’s August 26 speech in Jackson Hole, Wyo. Powell’s terse remarks focused on Fed mistakes in the 1970s that fueled double-digit inflation. He signaled policymakers would keep interest rates higher for longer to avoid a repeat, casting doubt on a pivot to a rate cut in 2023.

Be sure to read IBD’s The Big Picture column after each trading day for the latest information on the current stock market trend and what it means for your trading decisions.

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