{"id":36182,"date":"2023-07-15T19:34:11","date_gmt":"2023-07-15T23:34:11","guid":{"rendered":"https:\/\/ifintechworld.com\/markets\/the-fed-will-raise-rates-even-as-inflation-melts\/"},"modified":"2023-07-15T19:34:12","modified_gmt":"2023-07-15T23:34:12","slug":"the-fed-will-raise-rates-even-as-inflation-melts","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=36182","title":{"rendered":"The Fed Will Raise Rates Even As Inflation Melts"},"content":{"rendered":"
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Good CPI<\/h2>\n

The news of the week revolved around inflation. First, CPI (Consumer Price Index) on Wednesday (July 12). As we have forecast in past blogs, the rate of inflation has begun to melt. The +0.2% rise in both the headline (0.180% to the third decimal place) and core (+0.158%) was below the +0.3% expectation (for both). That brought the arcane year-over-year inflation rate to 3.09%.<\/p>\n

The year-over-year calculation doesn\u2019t say much about the current trend. The three-month and the six-month calculations give better trend information. The latest three-month annualized rate of change is 2.7%, while the six month is 3.3%; clearly headed in the right direction. The sub-index that Fed Chair Powell says is key, Services ex-Rent and Energy, actually deflated in June (-0.005%). What\u2019s the likelihood that Powell discusses this index at the July press briefing? (Answer: Nil)<\/p>\n

Better PPI<\/h2>\n

Then on Thursday (July 13), the PPI (Producer Price Index) headline number, at +0.1% for the month of June also came in below the consensus view (+0.2%). On a year over year basis, the annual rate of change in headline PPI is just +0.1%. This compares to +6.4% last December and +11.2% a year ago (June \u201922). Looking closer at the near-term trends, over the past six months, the annualized rate of change in PPI was -0.3%, and -0.7% over three months! Once again, the trend is toward lower prices! Looking at \u201cCore Crude PPI\u201d which measures prices at early stages of production and is a very reliable leading indicator for the more popular CPI, we note that June\u2019s month over month result was -2.4%, and this measure is -13.6% lower than in June \u201922. Note the steep downward trends in both the CPI and PPI in the chart at the top of this blog.<\/p>\n

Despite these very positive trends, Fed governors continue to tell their audiences that rates are going to stay \u201chigher for longer.\u201d As a result, the markets currently place 90%+ odds that there will be a .25 percentage point (25 basis point) rise in the Federal Funds rate at the upcoming July 26-27 Fed meeting. Given the trends in inflation noted above, and since monetary policy acts with long lags, it doesn\u2019t appear that an additional rate hike is needed. (And some commentators now argue that current rates are overkill \u2013 we are in this camp.) Nevertheless, it appears that such a hike is baked in, lest the Fed lose credibility and allow its influence on the free-market yield curve to be diminished.<\/p>\n

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The Fed did announce this week that James Bullard, the President of the St. Louis Fed, will be stepping down from his Fed post and will take a position on the Purdue faculty in mid-August. Bullard, who has been the most vocal rate hike hawk among the Fed governors, indicated that he would not participate in any rate setting discussions or decisions at the Fed\u2019s July meetings. We hope that this event marks the beginning of a more dovish Fed, as the data discussed above indicates, but we are not holding our breath.<\/p>\n

Projections<\/h2>\n

The table shows what the headline CPI would be if the monthly inflation rate remained at June\u2019s +0.2% (last column on the right). Because we see Recession ahead, we also included columns for +0.1% and +0.15%. Note that at the +0.2% monthly rate, the December \u201923 headline CPI would be 2.85%, and it would fall to 2.43% a year from now (right-hand column). As you can see from the table, at +0.1% or +0.15%, by this time next year, CPI headline would be 1.21% or 1.81% respectively, both well below the Fed\u2019s 2% target. Our opinion is that it is highly likely that we will see negative readings in the monthly CPI prior to year\u2019s end. So, we continue to scratch our heads as to why the Fed is pushing rates higher (credibility!). Perhaps the Bullard retirement is a sign of a more benign future Fed.<\/p>\n

Caution<\/h2>\n

A note of caution here. In the CPI column of the table, note the CPI index for May, June and July 2022. The headline inflation rate is simply the percentage change in the index over the prior 12 months. Thus, the 3.09% number is the percentage change from June \u201922 to June \u201923 (i.e., 303.841 vs. 294.728). Note that between May \u201922 and June \u201922, there was a very large leap in the index (from 291.268 to 294.728). This is known as the \u201cbase effect.\u201d The much larger denominator in the June \u201923 calculation impacted the annual percentage change calculation. That is partly why the headline rate of inflation fell a whole percentage point (from 4.13% to 3.09%). Now note that in July \u201922, the CPI index fell slightly (from 294.728 to 294.628). This will have a negative impact on headline CPI when July\u2019s CPI data are released in mid-August. Under almost any likely scenario, as shown in the table, if month over month inflation is between +0.1% and +0.2%, which would be very encouraging results, the headline year over year rate will rise<\/u><\/em><\/strong> to the 3.2% to 3.3% range. Once again, this would be due to the \u201cbase effect\u201d from a downtick in the index in July \u201922. This may cause a stir in the markets, but it isn\u2019t anything to be concerned about as long as the monthly change remains tame<\/em>.<\/p>\n

One more positive note on inflation: there is a strong correlation between the Institute for Supply Management\u2019s (ISM) Manufacturing Prices Paid Index and the CPI (see chart). If past is prescient, as is obvious from the chart, inflation will continue to melt.<\/p>\n

Employment \u2013 Less Than Meets the Eye<\/h2>\n

The employment reports from earlier in the month showed the headline Payroll Report number at +209K. This was the weakest reading in 2.5 years (since December 2020). The consensus view was for +230K, and this was the first time in 15 months that the consensus was higher than the actual.<\/p>\n

Starting with the +209K headline number:<\/p>\n