Inflation Up: Quick, Cut Rates NOW!!

Expect Dovish Fed Despite CPI, PPI Numbers

Jerome Powell took a victory march at his post-Federal Open Market Committee press conference last December. Monthly inflation rates had declined markedly during the second half of 2023, and investors anticipated up to six interest rate cuts during 2024. Senior central bank officials did little to dampen such expectations. But the claim to success proved premature. Inflation turned up again in the initial months of this year, putting off rate cuts which have yet to happen.

This has not stopped the Chairman or his top lieutenants from almost guaranteeing that the first rate cut since the peak 14 months ago will take place next Wednesday. Let us say that they want to ease policy just because they want to ease policy! Although monetary officials claim that their attention has shifted from prices to employment that would warrant an easier monetary policy, most recent labor market data suggest an economy softening rather than being on the precipice of recession. And remember, Powell has said repeatedly that a softer landing, and avoidance of recession, are the central bank’s objectives.

The latest unemployment rate of 4.2% is down from 4.3%, despite the labor force participation rate remaining steady at 62.7%. In other words, the lower unemployment rate took place even though the percentage of working age population that is employed, or looking for work, was unchanged from July. Initial jobless claims, an early measure of layoffs, has remained subdued with the latest weekly figure of 230,000 for the week ended September 7 up slightly, the first rise in three weeks.

These data-points suggest that the labor market shows no sign of recession. The employment situation appears to have become the main topic of concern only because the Fed has chosen to do so to justify its switch from focusing on lowering inflation.

And the Fed’s claim to success is not based on the performance of inflation either. We got figures for the Consumer Price Index on Wednesday, and the Producer Price Index on Thursday, both of which showed that authorities have a ways to go to achieve their price targets.

The annual increase in headline CPI did steadily decelerate from 3.5% in March to 2.5% in August prompted by a 10.3% fall in the retail price of gasoline, and 12.1% fall in the cost of fuel oil, over the past year. The fly in the ointment was the 0.5% monthly increase in the cost of shelter in the latest data, repeatedly the focus of recent SriKonomics issues as an enduring factor behind elevated inflation. The increase in shelter cost was 5.2% over the past year. Core CPI inflation, which excludes food and energy, accelerated to 0.3% in August, the most rapid rise since April. Consequently, the year-on-year core inflation stayed stubbornly at 3.2%, unchanged from July. The Fed’s target is 2%.

No relief in the PPI either. Producer prices sped up by 0.2% last month after remaining flat in July.

None of these factors — lack of recession signals from the labor market and the persistence of inflation — has stopped investors from anticipating an interest rate cut of at least 25 basis points on September 18. Why would Fed officials want to feed such expectations rather than state clearly that policy easing will not take place in the absence of clearer signals on the price or employment front? Because such a statement would so disappoint investors that a massive correction in equity valuations, and a surge in Treasury yields, would follow a decision to keep rates unchanged.

And with a 25bp reduction in rates already built into expectations, anticipation of a 50bp cut has been rising in probability over the week, with investors believing by last night that whether the reduction turns out to be 25bp or 50bp would be a coin-toss outcome. And why not? If a market tantrum such as that on August 5 could force the Fed to reduce the Federal Funds rate by 25bp, markets could have a bigger fit forcing the central bank to reduce by 50bp.

And what would Fed easing do to the real economy? As we know from past instances, lower interest rates would put more money in consumer and investor wallets, and boost spending and retail sales. With US gross domestic product expanding by 2.5% in the current quarter according to the Federal Reserve Bank of Atlanta’s latest GDPNow estimate (September 9), expect GDP growth to accelerate and upward pressure on prices to increase.

What can Jerome Powell do to correct the situation? The Fed Chairman can react at his press conferences by shedding more than the usual figurative tears at feeling the pain of consumers having to deal with the high cost of essentials. If policy will not support inflation mitigation, perhaps showing some emotion can!

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

September 14, 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.

This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Sri-Kumar Global Strategies, Inc. assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. Sri-Kumar Global Strategies, Inc., or its employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time without notice. ©Copyright 2024 -- Sri-Kumar Global Strategies, Inc., 312 Arizona Avenue, Santa Monica, California 90401; Telephone: +1-310-455-6071