The Fed remains unlikely to hike rates at next week’s policy meeting
The latest inflation report on consumer prices in August came in a hair above expectations. Focusing on the month-over-month numbers, headline inflation came in at 0.6%, which was in line with expectations, because of higher gas prices. Core inflation was 0.3%, which was slightly above expectations of 0.2% and last month’s read of 0.2%.
Today’s report is a bit less straightforward than recent months’ reports. The past two consumer price index (CPI) reports contained straightforward good news for inflation. Coupled with excellent news on the job market side, sentiment clearly swung to the “soft landing” side. This report is disappointing, but it’s important to remember that the path to the Fed’s target was never going to be a smooth one. Overall, the inflation rate is coming down on a bumpy and jagged path, just like we’d expect it to.
Worries About Still-Hot Labor Market Persist
Still, today’s report was disappointing for two reasons:
- Headline inflation (everything including food and energy) jumped way up to 0.6% month over month because gas prices were up 11%. But the Fed doesn’t pay much attention to headline inflation because it’s a poor predictor of future inflation. Food and energy prices are inherently noisy, so it’s not a good measure of underlying price pressure in the economy.
- Core inflation (everything excluding food and energy) came in a little higher than expected at 0.3% month over month. It had been at 0.2% for the past two months and we had expected that to continue. Since the Fed’s target is 2-2.5% annual inflation, 0.2% is consistent with that, but 0.3% is too high. But of course there will be ups and downs over the course of the year, so this isn’t cause for panic, but it is a reason to remain wary. Within core inflation, shelter inflation came down, but core services excluding shelter was up sharply. This does lead to worries about the still-hot labor market and whether we will need unemployment to increase in order to finally get inflation to target.
The Fed is Unlikely to Surprise Us With a September Rate Hike
However, the Fed remains extremely unlikely to hike next week. If there is anything to know about the modern day Federal Reserve, it is that they do not surprise markets. Markets are not expecting a hike next week, and since the Fed is in its quiet period right now, the only way to warn the market about an impending hike would be to leak it to the press, which they did in June 2022, but this isn’t a big enough surprise for them to pull something like that again. Also, the Fed Funds rate is well within the range where it’s dragging down the economy, which means that monetary policy is working even without another hike.
A Year-End Rate Hike is a Possibility, Not a Certainty
The Fed is in fine-tuning mode right now, and this data shifts the balance in favor of another hike in November or December. However, it’s not absolutely clear at this point that another hike is needed, and certainly not immediately. While we’re all reading the tea leaves of every number in every report, it’s also important to remember that the data is noisy from month to month. Everything could look very different next month depending on whether inflation ticks up or down from here. Since we’re already at 5.5% on the federal funds rate and the Fed just hiked in July, we have the luxury to wait for the next meeting and let more data come in.