Despite Powell, Voices of Reason at Fed

Some Policymakers Take Their Anti-Inflation Mandate Seriously

The 1,000 point drop in the Dow Jones Industrial Average on August 5 had market players, a former policymaker and a learned Professor clamoring for an immediate and sharp reduction in the Federal Funds rate. Without policy easing, they warned, the US economy would fall into recession. One observer believes that it may already be too late for the Federal Reserve to prevent a serious economic downturn.

Since the plunge in risk assets that Monday, US markets have been up sharply without any action by the Fed. Last week was the S&P 500 index’s best during 2024. But many of these same analysts continue to call for one or more rate reductions starting next month.

Among the factors responsible for the market surge was the publication of the US Producer Price Index on Tuesday, and the Consumer Price Index on Wednesday, both deemed benign by investors. The headline PPI rose by 0.1% in July, slowing from the 0.2% increase in June. Compared with July 2023, the PPI increased by 2.2%, slowing significantly from 2.7% during the year ending June. These were undoubtedly good numbers. But recall that the PPI rose by only 0.1% last November, and fell by 0.1% in December, before surging by 0.6% in February. History suggests that month-by-month inflation figures are not a reliable guide to the path of subsequent inflation.

As for the CPI, slowing of year-on-year inflation from 3% in June to 2.9% in July — coming under the 3% threshold — was exciting and led investors to believe that a rate cut on September 18, at the conclusion of the two-day meeting of the Federal Open Market Committee, was a certainty. The only doubt in some investors’ minds was the size of the rate reduction. What markets downplayed was that the month-on-month CPI inflation accelerated from May and June. The index was flat in May and fell by 0.1% in June before rising by 0.2% in July.

And below the seemingly benign headlines, there were signs of danger. The rise in shelter cost (rent), outlined recently in SriKonomics as a persistent problem, was 0.4% last month and is running at 5.1% over the past year. Surging home prices and elevated mortgage rates are pushing more potential first-time home buyers into the rental market — a situation that is not likely to be remedied any time soon. And shelter has a significant 36% weight in the CPI basket.

Lastly, do consumers, whose spending constitutes some two-thirds of US gross domestic product, need Fed support in the form of lower interest rates? We learned Thursday that retail sales rose by a full percent in July, compared with the 0.3% rise that the consensus had anticipated. Retail sales have risen by a strong 2.7% over the past year. Even without including the strong 3.6% month-on-month rise in vehicle sales in July, retail sales were up 0.4%.

Also providing information regarding consumers, initial jobless claims, an early indicator of labor market performance, fell by 7,000 in the latest week to 227,000. This does not suggest surging joblessness but the opposite. Initial jobless claims have fallen for two weeks in a row after the Chairman told us that the Fed had shifted its attention from inflation to the jobless situation because of greater concern over the employment situation.

These are some of the recent data that have been released since Jerome Powell’s press conference on July 31. “The broad sense of the Committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate,” the Chairman asserted on that occasion. And if the Fed’s confidence regarding inflation and the labor market was met, “a reduction in our policy rate could be on the table as soon as the next meeting in September.”

Compared with Powell’s eagerness to ease policy despite indications that September would be too soon to lower rates, Atlanta Fed President Raphael Bostic said Tuesday that he needs to see “a little more data” for him to support a cut in interest rates. He seemed confident that the Fed was moving toward its 2% inflation target but is just unsure of the timing.

Even more careful in her remarks was Federal Reserve Governor Michelle Bowman. Speaking last Saturday, she said “Given that supply constraints have now largely normalized, I am not confident that inflation will decline in the same way as in the second half of last year.” She further cautioned that “we need to be patient and avoid undermining continued progress on lowering inflation by overreacting to any single data point.” This appears to be a polite way of disagreeing with the Fed Chairman who has repeatedly claimed that the central bank is “data dependent” while using the latest data to support his expectation of lower interest rates.

The question is: Whose view will eventually dominate, those who are cautious in worrying about a slowdown in inflation mitigation, or those who want to behave as cheerleaders for equity investors? As the Fed faces a crucial fork in the road, how the officials conduct policy over the coming weeks will have a significant impact on the path of inflation and economic growth over the next twelve months.

Look for the first indication of future policy in Powell’s speech at Jackson Hole, Wyoming next week. I will be closely watching how he justifies the initiation of rate cuts next month with the economy being strong, and the inflation target not yet met.

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

August 17, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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