The Federal Reserve should declare an immediate ceasefire in its war on inflation and keep its benchmark interest rate steady instead of raising the federal funds rate by half a percentage point to a range of 4.25% to 4.50%, as expected at its next meeting. ends Wednesday. .
With the relatively benign report on the consumer price index in November released on Tuesday, the Fed now has “compelling evidence” that it has achieved its immediate goal of seeing a significant slowdown in inflation.
The KPI was better than expected in November, with headline inflation rising just 0.1% (1.2% annualized) and core inflation up 0.2% (2.4% annualized).
Read: Inflation is slowing, but the battle is far from over
US stock market SPX,
on Tuesday initially hailed the CPI report as confirmation that the Fed could begin to let up, but in the middle of the day the realization hit that the Fed will keep hiking rates.
Market Snapshot: The Dow clings to gains in the final trading hours as Wall Street gauges fresher inflation reports, the Fed’s next rate decision.
Better than the media says
The CPI report was actually better than the media portrayed it, which continues to irrationally focus on year-over-year changes in inflation rather than looking at what has happened since the Fed began raising interest rates nine months ago. For example, what we have to do. this incoherent headline in the New York Times: “US inflation cools as consumer prices rise 7.1 percent”?
If we do not want to miss the turning points, we must shorten our horizon to something less than a year, but not so short that it is all noise and no signal. Three months is about right.
In March 2022, when the Fed first raised rates, inflation accelerated. From January to March, the CPI rose at an annual rate of 11.3%. This was an alarming inflation rate that called for action by the Fed.
But then the Fed raised interest rates in six straight meetings, going from near zero to near 4% and now inflation is slowing down. From September to November, inflation rose at an annual rate of 3.7%.
That is significant progress in the most important measure of inflation.
Read: Why November’s CPI data is seen as a ‘game-changer’ for financial markets
The perspective is bad
The progress is much less apparent when the figures are reported on a year-over-year basis, as most media outlets do. From November 2021 to November 2022, inflation rose 7.1% – but this figure is meaningless to our understanding of what the Fed accomplished because this time period also includes five months of high inflation before the Fed acted.
Because rate hikes take some time to have an impact on prices and the economy, they didn’t really start to bite until July. In the five months since then, inflation has slowed to an annualized rate of 2.5%, noticeable to anyone who is looking. Unprecedented increases in interest rates are working to cool price increases.
The progress is even greater when you consider that almost all the inflation we have suffered recently comes from higher rents, which are now rising at an annual rate of 10% in a delayed response to the incredible increase of 20% + last year in. home prices and tight rental markets.
Rents continue to rise while house prices fall
Home prices have started to fall now in most regions of the United States. Rents for new tenants have also started to fall, but rents for continuing tenants have lagged and may take another year or more to catch up, according to research economists at Goldman. Sachs. That’s because existing rents tend to reset on an annual basis.
“ Rents are used to calculate costs not only for renters, but also for homeowners. It’s as if we measure the price of champagne by looking at how much beer costs. “
With more than 900,000 multifamily housing units currently under construction, supply constraints will soon begin to ease, reducing pressure on rents, when those units hit the market, likely in the next year or so.
Rents have a large influence on the CPI, because rents are used to calculate costs not only for renters but also for homeowners. It’s as if we measure the price of champagne by looking at how much beer costs. Yes, there is some correlation most of the time, but not always.
Using rents to measure home ownership costs might be an acceptable methodology in normal times, but not now. Based on the increase in rents, the CPI showed that housing costs for homeowners increased at an annual rate of 8% in November. No one believes it is true. Most homeowners have a fixed-rate mortgage, so principal and interest payments don’t go up.
The right perspective
The best thing to do in this situation is to recognize that we need to exclude shelter costs (which account for a third of the CPI) if we want to see where hidden inflation is heading.
“Substantial disagreement over the correct way to measure shelter inflation argues for looking at inflation measures that put less weight on shelter inflation, not more, when the decision is of greater consequence,” wrote Goldman Sachs economists Ronnie Walker and David Mericle. in a published note. in October.
The KPI excluding shelter fell 0.2% in November and rose at an annual rate of just 1.3% over the past three months.
Even Fed Chairman Jerome Powell has acknowledged that a sudden drop in home prices won’t show up in the CPI headline for months, but he doesn’t act like he really believes it. If he did, he would urge his colleagues at the Fed to pause now and let the full impact of 375 basis points of tightening work on the economy.
More: The Fed saw a slowdown in the quarter-point increase in February after soft consumer price inflation readings
We know, however, that the Fed will not pause. The Fed lost too much credibility last year when it missed the rapid rise in inflation as the economy emerged from its pandemic shutdown, and now the Fed is fighting to restore public confidence as an inflation fighter.
Unfortunately, this makes a recession almost inevitable, because the Fed will do what it always does: Raise rates too far and push the economy into a job-killing recession.
Rex Nutting is a columnist for MarketWatch who has written about the Fed and the economy for more than 25 years.
Rex Nutting on inflation
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