Progress is being made, but the Fed wants more
At a recent FOMC press conference, Federal Reserve Chairman Jerome Powell said the economy “could make fairly significant progress on inflation without seeing the increases in unemployment that are typical of rate hike cycles like this one.” I was able to do it.” Nevertheless, there was recognition that there was a long way to go in the process of sustainably reducing inflation to 2%.
Headlines US consumer price inflation has indeed declined significantly from its peak of 9.1% year-over-year in June 2022, hitting a low of 3% in June 2023. However, this stalled in August and September, with the annualized rate rebounding to 3.7%. This was due to strong summer consumer spending, rising energy costs and renewed resilience in some core components (excluding food and energy). The annual core inflation rate has continued to slow from its peak of 6.6% in September 2022 to 4.1%, but remains at a level that is more than twice the target of 2%.
In an environment where the economy had just recorded an annualized growth rate of 4.9% in the third quarter and the unemployment rate was only 3.9%, the FOMC argued that it could not take the risk and called for further interest rate hikes. There are a few hawks who continue to advocate. and allowing every opportunity for inflationary pressures to flare up again.
Contribution to US annual consumer price inflation rate (YoY%)
But the Fed’s job is probably done.
The Fed still officially expects one more 25 basis point rate hike this year, but it is questionable whether that will happen. The Fed last raised interest rates in July, and since then financial and credit conditions have tightened, with interest rates on mortgages and auto loans now above 8%, while credit card borrowing costs have hit record highs. , corporate lending interest rates are rising.
Rising borrowing costs are not the only brakes on economic activity and curbing inflationary pressures. Banks are becoming more reluctant to lend, according to a poll of senior loan officers from the Federal Reserve. This combination of rapidly rising borrowing costs and declining credit quality tends to be detrimental to growth. While the Fed itself has reported a sharp decline in loan demand, commercial bank lending data shows that household and business borrowings have clearly reached a plateau. Real household disposable income has fallen over the past four months, with GDP expected to contract by at least two quarters in 2024, as it becomes clear that a growing number of households have exhausted their pandemic-era savings. Masu. In this environment, we expect the slowdown in inflation to recover. It will gain momentum in early 2024.
Corporate pricing power is declining
We are seeing a decline in price intention surveys as companies become more cautious about the economic outlook. The graph below shows the relationship between the National Federation of Independent Business (NFIB) survey of the percentage of members expecting price increases in the coming months and the annual core inflation rate. This suggests that core inflation is expected to return to historical trends and that conditions are normalizing.
NFIB’s Price Intentions Survey Suggests Corporate Pricing Power Is Normalizing
While concerns about the demand outlook are the main factor limiting companies’ appetite for further price hikes, a more benign cost backdrop is also supporting the situation. Annual producer price inflation slowed from 11.7% to 2.2% and fell to just 0.3% year-on-year in June, while import prices fell completely year-on-year. There are also signs of a loosening in the labor market, with the unemployment rate starting to rise and average hourly wage growth slowing to 4.1% from nearly 6% just 18 months ago. Perhaps more importantly, non-agricultural productivity soared in the third quarter, with unit labor costs falling at an annualized rate of 0.8%. Cost pressures appear to be easing from all angles, so core services other than housing, a factor the Fed is watching closely, will likely ease significantly in the coming months.
Fed’s ‘supercore’ inflation should slow even more rapidly
Energy and car prices fall, curbing inflation.
Another area that has been encouraged recently is energy prices. There were concerns that the conflict in the Middle East would affect energy markets, but so far energy prices have softened. U.S. gasoline prices fell 50 cents per gallon from mid-September to early November, bringing prices to their lowest level since early March. The weight of gasoline in the CPI basket is 3.6%. U.S. commodity strategists remain cautious, warning that an escalation in the conflict could lead to disruptions to oil and gas supplies from some of the region’s major producers, particularly Iran. But for now, headline prices have been significantly lower than they have been for at least a month or two, as energy prices are pushing down on inflation, and lower energy prices limit the upside room for airfares (0.5% weight in the CPI basket). There is a possibility of a decline.
In addition to this, we expect new and used car prices (combined 6.9% weight in the CPI basket) to be susceptible to further price declines in an environment of rising auto loan borrowing costs. New car prices have increased by more than 20% since 2020 due to supply issues and strong demand, while used car prices have increased by more than 50%, according to both CPI measurements and Mannheim Auto Auction Prices. Used car prices have fallen this year, but are still 35% above 2020 prices. The average payment for a new car loan is currently about $730 per month, compared to $530 per month for a used car, according to data from Experian.
The cost of car insurance is also rising rapidly (up 18.9% year-on-year, weighting 2.7% in the CPI basket), making the cost of buying and owning a car increasingly prohibitive for many households. , regarding vehicle prices, where incentives are likely to further suppress upward prices. It’s also important to remember that rising insurance costs have been slow to react to rising vehicle prices, and therefore insurance amounts, which will slow down rapidly (but not fall) in the coming months. It is important.
Gasoline and crude oil prices unexpectedly fall
Sluggish rents will become a major source of inflation in early 2024.
The big disinflationary impact should come from housing over the next few quarters. The graph below shows the relationship between Zillow’s rent and the housing component of his CPI. This is because owner-equivalent rent is the single largest individual component of the basket of goods and services used to construct the CPI index, accounting for 25.6% of the headline index and 32.2% of the core index. It is important. Meanwhile, prime rents account for 7.6% of the composite index and 9.6% of the core index. If this relationship holds and the inflation rate in the housing component of the consumer price index slows to 3% year-on-year, then the one-third weight of housing in the headline interest rate and the 41.8% weight of the core will be the same as the headline inflation rate. That would be about 1.3 percentage points less than the core annual inflation rate and 1.7 percentage points less than the core annual inflation rate. inflation rate.
Rent signals significant inflation in house prices
Inflation on track to reach 2% next summer
While there are some factors that are less certain, such as health care, there is growing confidence that inflationary pressures will continue to decline, meaning the Fed will not need to raise rates any further. In next week’s October CPI report, the headline CPI is expected to be flat for the month and core prices are expected to rise by 0.3% from the previous month, so there may not be much progress, but the December report shows that the headline inflation rate is expected to increase at an annual rate. It is expected that the decline will slow to 3.3%. Core inflation he will fall to 3.7%.
An even sharper decline is expected in the first half of 2024. Chairman Jerome Powell acknowledged in a speech at the Economic Club of New York that “given the pace of tightening, there may be more meaningful tightening in the future.” This will only increase disinflationary pressures in an economy that is showing signs of cooling down. We expect headline inflation to be in the 2-2.5% range from April onwards, with core CPI testing 2% in the second quarter.
Growth concerns could rise over the same period, which should give the Fed flexibility to respond by cutting rates. We wouldn’t necessarily describe this as a stimulus package, but rather as a move to a more neutral position in monetary policy, with the federal funds rate at 4.5% versus the consensus estimate and market price of 4.5%. % is expected to reach the end of 2024.
ING CPI Forecast (% YoY)