US Inflation Report Shows Fed’s Battle Is Far from Over

The prospects of avoiding inflation in the US have steadily improved in recent months, but last week, right in the middle of a two-day Federal Reserve policy meeting, that scenario fell apart.

Monthly reports on consumer and producer prices released on the mornings of December 12 and 13 indicate that inflation over the past six months has likely returned to the central bank’s target of two percent on an annual basis, Bloomberg reported.

The surprising turn of events prompted some Fed officials to hurriedly revise their projections that were set to be released on the afternoon of the 13th. It also increased confidence among forecasters that the next six months will look more or less the same.

The monthly report from the US Bureau of Economic Analysis, which is set to be officially released on Friday morning, is ready to announce this achievement, helping to bolster arguments for lower interest rates in the upcoming quarters.

Throughout 2022 and the first half of this year, Fed watchers had become accustomed to ‘just focusing on realized inflation,’ said Blerina Uruci, chief US economist at T. Rowe Price. – Now the Fed is focusing on inflation outlooks to avoid exceeding its target – she said.

The Fed’s preferred inflation indicators (the personal consumption expenditures price index and a measure that excludes food and energy) utilize several input data from two reports from the Bureau of Labor Statistics released last week. Together, they showed ‘softening’ in key categories such as goods excluding food and fuel, financial services, and certain health components, prompting forecasters to revise their estimates for the PCE price measure.

– Far from facing the widely expected ‘last mile’ problem, it seems that core PCE inflation has slowed from four percent on an annual basis in the first half of 2023 to 1.9 percent in the second half of the year – said economists at Goldman Sachs led by Jan Hatzius in a client note dated December 13.

Fed Chairman Jerome Powell and his colleagues are now prepared to lower interest rates ‘earlier and faster,’ starting in March, ‘to reset the benchmark rate from a level that most policymakers will likely soon see as a distant contrast to an inflation trend near 2 percent,’ they said.

Goods a Major Driver of Disinflation

Many economists have particularly highlighted the broad weakness in goods as a significant aspect of easing surprises.

– A very simple example is that clothing prices in November in the consumer price index fell the most in November since 1942. We have seen this in other categories such as household furniture, furniture prices, electronics. Whatever you say, core goods have been much weaker than expected in the last month or two – said Omair Sharif, president of Inflation Insights LLC.

While goods have been a significant driver of faster-than-expected disinflation in recent reports, service prices (an area that Fed officials have been particularly focused on this year) have also generally risen more slowly. This is a major reason why forecasters are becoming increasingly confident that the next six months will show that overall inflation will remain close to the Fed’s target of two percent.

– Evidence suggests that the economy can grow at a modest pace at the same time that inflation is decreasing. This puts the Fed in a favorable position where it will likely be able to track inflation without reducing demand as much as they thought they would have to – said Michael Gapen, chief US economist at Bank of America.

Despite this, there are several potential hurdles to address in the first quarter.

Lower stock prices have helped pull components of the financial services price index lower in recent months, but new highs in the stock market since last week’s Fed meeting are likely to push those components back up.

Overall, rent increases (the largest and most important component of the price index) are expected to be moderate based on leading indicators, although the exact timing is unclear. There is also uncertainty surrounding upcoming changes to the ‘seasonal adjustment’ of monthly inflation data, Bloomberg writes.

However, none of this is enough to deter forecasters from dismissing the optimism shown in the latest numbers.

– I don’t know if we had any real empirical evidence suggesting that the ‘last mile’ would be tough, but people have run with that line. I mean, it sounded interesting – Uruci said.