Inflation Good News
Admittedly, it is difficult to write both “inflation” and “good news” in the same sentence. Inflation is not a good thing, but falling inflation is encouraging and that has both stock and bond markets cheering. June’s Consumer Price Inflation report, released this week, showed that headline inflation, which includes the volatile food and energy components, rose just 3% year over year. Core inflation, which most economists consider a more reliable indication of the trend in inflation, rose 4.8% year over year. While inflation remains above the Federal Reserves 2% target, the trend is in the right direction having fallen significantly from Last July’s 8.5%.
As we discussed at our annual investor conference, we still consider inflation one of the most critical factors to watch. The Federal Reserve is attempting to bring inflation down without causing a deep recession. They are trying to walk a narrow path with a ditch on both sides. On the one side, if they do not raise rates enough, inflation may become entrenched and remain out of control. On the other side, if they raise rates too much, they may cause a deep recession, killing inflation but also killing the economy. The risk of policy error in this environment is high. Nonetheless, this week’s data shows that the Federal Reserve is still on the path.
Will inflation continue to decline? That is certainly the key question for the year. Despite the encouraging inflation news, the Fed has a couple of areas that could keep inflation persistently above their 2% threshold. First, the labor market remains very tight, which usually feeds inflation. Secondly, rent inflation, a significant factor in the Consumer Price Index (CPI), remains high at 8.3% year over year. Rent tends to be a lagging inflation factor since lease contracts take time to renew. Thus, rent inflation accelerates more slowly, but also decelerates more slowly than many other types of inflation. There are signs that rent inflation has peaked and is coming down, but it is important to see continued moderation in the labor market and rental market before the Fed can claim victory on the inflation front.
In June the Fed chose to keep rates steady at 5.0% - 5.25%. The Fed’s next meeting will be July 25th and 26th. and the market expects the Federal Reserve to raise rates one more time for an additional 0.25%, bringing the Fed Funds target rate to 5.25% - 5.5%. Could this be the final rate hike for the year? The Federal Reserve chairman, Powell, has reinforced several times that the Fed may still need to raise rates several times this year. Markets appear to expect just a July hike and then at least a significant pause. Moderating inflation could give the Fed room to take the rest of the summer off.