Fed Hawk Down
Someone go check on the health of the Fed hawks. The wind has been taken from beneath their wings.
The benign inflation report released Wednesday confirms earlier data suggesting there is no need for a rate hike from the Federal Reserve later this year.
The consumer price index climbed 0.1 percent in July compared with June. That followed the prior month’s 0.4 percent decline. Although the year-over-year rise in CPI is still uncomfortably high at 3.4 percent, this was the second month in a row in which it headed down. The three-month annualized rate is now just 0.5 percent. Even with the personal consumption expenditure index unusually running hotter than CPI, this indicates we’re currently below the Fed’s two percent PCE inflation target.
Core CPI, which excludes food and energy prices, rose 0.2 percent for the month. Compared with a year ago, it is up 2.4 percent. Three-month annualized core CPI is now 1.6 percent.
On the three-month annualized basis, headline CPI is now the lowest it has been since June 2020—when prices were actually falling because of the pandemic lockdowns. Three-month annualized core CPI is the lowest it has been since July 2024, which was just before the Fed began cutting interest rates.
Median CPI rose 0.3 percent, according to the Federal Reserve Bank of Cleveland. That’s a bit on the high side but not alarmingly so. From a year ago, it is up 2.7 percent, and the figures over the latest three months annualize to three percent. The Cleveland Fed’s 16% trimmed mean measure came in at 0.2 percent for the month and 2.6 percent for the year. The three-month annualized figure is just two percent. These suggest that underlying inflation is not threatening to pull prices off the Fed’s target.
Labor Pains Mean No Inflation Gains
The data from the labor market also weigh against a hike. Average hourly wages rose just 0.05 percent in July, and the three-month annualized figure shows a 2.3 percent pace of gains. That’s consistent with meeting the Fed’s target, perhaps with undershooting it. The decline in payrolls also indicates little inflationary pressure from the labor market.
Business inflation expectations are mild. The Atlanta Fed’s measure showed unit costs are expected to rise 2.2 percent. While that is above the pre-pandemic average, in the pre-pandemic era the Fed was regularly undershooting its target. The current number is fine.
The arguments of the hawkish Fed presidents seem increasingly misplaced. The core case for concern over inflation is that repeated “one-off” supply shocks that raise headline inflation could disrupt inflation expectations. This does not seem to have happened. The median expected rate over the next five years is three percent, which is historically consistent with the Fed’s target. The Cleveland Fed’s measure of expected inflation over the next five years—based on surveys, Treasury yields, and prices of inflation-protected bonds—is 2.4 percent. So there’s no sign of this fear becoming a reality.
Beth Hammack, President of the Cleveland Fed and one of those who advocated for a hike at the last meeting, sounded confused in a recent post on LinkedIn about inflation in her district:
Now is the time to act.
There’s no tension in the mandate. Policy isn’t restrictive. And the longer we wait to take action to bring inflation back to our 2 percent objective, the more challenging it will be to bring it back down and the more expensive it will be for the American people.
In this sixth year of elevated inflation, for Fourth District residents, it’s already expensive.
• For the Sandusky, Ohio restaurant owner who had to drop his building insurance after seeing the premiums triple in three years.
• For the mid-sized Wooster, Ohio manufacturer that can’t raise prices despite soaring input costs.
• And for the Erie, Pennsylvania worker who has to tell his kids he can’t get them the ice cream they ask for because he just doesn’t have any extra cash.
While those bullet points certainly highlight the pain inflation has inflicted on consumers, they are actually signs of disinflation. A restaurant owner turning down insurance means his income cannot support current prices. The Ohio manufacturer cannot pass on “soaring input costs”—which means demand is insufficient to support higher prices. The guy who cannot buy his kids ice-cream? That’s also a testament to disinflation rather than inflation.
It’s important to keep in mind that the Fed’s inflation target—which embodies its statutory obligation to pursue price stability—is solely focused on consumer-facing inflation. It looks at how inflation is affecting household spending as seen in the personal consumption expenditures price index. Even the alternative measures that some Fed officials have considered are measures of consumer inflation. The Fed could target business inflation, looking at input costs, but it does not. What matters for Fed policy is consumer inflation.
There will be one more CPI report and a single PCE price index before the Fed’s next meeting. To justify a hike in September, these would have to show a large jump in inflation. That’s improbable given the recent softness in jobs and wages. The Fed will most likely keep rates unchanged when it meets next.