US Inflation Has Turned “Sticky”, Reducing Odds For Rate Cuts
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
US consumer inflation at the headline level in November ticked up to a 2.7% annual rate – the fastest pace since July. The core rate of CPI – seen as a more robust measure of the trend – held steady at 3.3%. The latest numbers appear to have raised concerns that progress on lowering inflation has stalled. In turn, the firmer reading may present a challenge for the Federal Reserve and the economy. A closer look at various metrics leaves room for debate about how pricing pressure evolves in early 2025, but the latest updates will likely convince the Fed to remain cautious on cutting rates until there’s more confidence that inflation will move closer to the central bank’s 2% target.
One way to measure the overall inflation bias is monitoring the spread for headline and core CPI on a rolling one-year basis. History suggests this measure provides a rough estimate of the strength or weakness of inflationary pressure. When the spread is negative, as it currently is and has been for a year-and-a-half, that’s a sign that the disinflationary bias is relatively strong. On that basis, disinflation momentum remains robust. The drawback to this metric is that it’s backward-looking and is starting to conflict with forward-looking indicators that appear to shifting to a reflationary bias again in December, as shown below.
The Cleveland Fed’s inflation expectations model offers an ex ante view and on that basis it’s clear that a whiff of reflation has returned recently. The question is whether the latest upturn pushes above the previous highs (roughly 2.7%). Until then, it may reasonable to assume that the upturn is noise.
Another measure of inflation expectations also highlights a whiff of reflation via five-year inflation expectations based on two models. One model uses the 5-year/5-year forward expectation rate, as calculated by the St. Louis Fed. The second model uses the implied market forecast according to the 5-year nominal Treasury yield less its inflation-indexed counterpart. The average of these two models edged higher for a second month to 2.4%, the highest level in more than a month. This could be noise, as long as the rise doesn’t take out the previous high. But if the average outlook reaches 2.4% and moves higher it would signal a significant shift to reflationary conditions.
Finally, the average of a set of alternative and conventional inflation indicators are picking up on firmer reflation pressure. The logic for using a wider set of inflation metrics: the standard consumer price indexes, published by the Labor Dept., may be flawed in some degree. In fact, any one measure of inflation reflects a particular set of pros and cons. Expanding the data set to a range of indicators offers the opportunity to strengthen the analytics and calculate a closer approximation of the true inflation rate. On that basis, estimating the average change in CPI via a broader set of inflation benchmarks arguably provides a clearer measure of the trend. The average rate of inflation for this expanded set of benchmarks strengthened to 2.3% year-over-year through November—the highest since May. If this average continues to rise in the upcoming December report it will bolster the case for arguing that reflation is picking up again, and so the Federal Reserve needs to respond by pausing rates cuts for the near term if not raising rates and re-tightening monetary policy in some degree.
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