On August 10 at 8.30am ET Consumer Price Index data for the month of July will be released, revealing the latest U.S. inflation trends. The prior reading for June was encouraging as headline inflation rose at a 3% annual rate and the monthly increase in core CPI was 0.2%, the smallest increase since August 2021.
After a lot of the large price spikes from 2022 have rolled off of the CPI series, so reducing inflation, especially core inflation, further in the second half of 2023 may be slower going. Broadly, this is the Federal Reserve’s perspective and accounts for why they expect to maintain interest rates at relatively high levels into 2024 if that assessment holds.
Nowcasts
Nowcasts from the Federal Reserve Bank of Cleveland for upcoming inflation releases suggest that the next two CPI report may not be what the Fed is looking for. Specifically, looking at energy price trends and other observable prices to estimate inflation data before its official release, they estimate that July and August core CPI will rise at a 0.4%.
That would support the Fed’s concerns that the inflation battle is not over. It may also provide support for another interest rate hike in 2023, something the Fed is actively considering. However, though inflation nowcasts are useful and superior to many other inflation estimates, in recent months they have tended to overestimate inflation. For example, we have started to see disinflation in shelter costs in 2023 so far, as a large component of CPI, that may help drive inflation lower.
The Fed’s Reaction
The Fed continues to watch inflation data closely. Generally, they prefer the PCE inflation metric, which is released later in the month August 31, however the two series are strongly correlated. As such, markets often react to the early inflation read that CPI provides. Additionally, the release of wholesale inflation data (PPI) on August 11 will be helpful too.
The Fed’s next meeting is on September 19-20, as so they will have August’s CPI reading as well for their next interest rate decision. The Fed’s concern is that even though inflation is falling, services inflation remains high fueled by wage costs. Hence the Fed would need to see evidence of disinflation in services in the CPI reports for the months of July and August to start to have more confidence that inflation is beaten. That’s something the Fed is not confident they’ll see, and why the Fed suspects another hike in rates in 2023 may be needed.
However, we likely are close to the top of this interest rate cycle and the Fed has emphasized data dependence. Therefore, the next two CPI readings are likely to inform the path for interest rates. In addition, employment remains a wildcard too, that’s the other part of the Fed’s economic goal and if that softens, then that could alter the path of interest rates as well.
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