On July 11, the Bureau of Labor Statistics reported that price levels, as measured by the consumer price index (CPI), deflated over the month. The topline CPI fell 0.1 percent from May to June; the first such reading since May of 2020. The less volatile core reading posted the lowest monthly gain since August of 2021. On a yearly basis, both measures are at post-pandemic lows. On an annualized basis, average core CPI over the last three months is within 20 basis points of the Fed’s target.
In Chairman Powell’s recently released semiannual Monetary Policy Report, he well characterized the stance of current policy, citing progress in “lowering inflation and cooling the labor market.” The labor market has indeed cooled: over the last three months the monthly pace of employment growth has fallen by about 30 percent, while the unemployment rate has increased by 10 basis points each successive month.
With the most recent reading, and recent coolness in the labor market, risks from inflation and labor market deceleration now appear to be coming into balance. Mindful of the Federal Reserve’s dual mandate to promote stable price growth and full employment, expectations for easing monetary policy will continue to grow. But recent research shows that even as gauges of inflation and employment seem somewhat in balance, risks from inflation may be more persistent.
A recent paper by Drs. Christina and David Romer studied multiple periods of high inflation and the related Federal Reserve response. The researchers assessed the central bank’s responses based on how “committed” the Fed was to taming inflation. The upshot of the research finds that weak or modest commitment typically results in premature easing of monetary policy, leading to more persistent inflation. In cases where the Fed was committed to taming inflation – even at the expense of employment and economic growth – inflation was brought to heel. As risks to growth and employment increase, however, expectations for timing a rate cut sooner rather than later will grow.
For example, a recent research note from Goldman Sachs’ Jon Hatzius, titled, “Why Wait?” makes a case for easing interest rates at the Federal Open Market Committee’s next opportunitylater this month. Market observers are nearly unanimous in expecting a 25-basis point rate cut in September, but virtually none expect a July cut. One nagging concern is that inflation has waxed and waned periodically in the current cycle.
While broadly trending down as the Federal Reserve’s restrictive monetary policy has taken hold, by multiple measures, inflation has proven somewhat stubborn. The Fed’s preferred measure of inflation, the core personal consumption expenditure (PCE) index, is less volatile than topline CPI. But it too has appeared to have moderated before stubbornly rising for several months.
Another confounding factor is the election. The Federal Reserve will have two more reads on employment and inflation (PCE) before the September meeting. The next meeting thereafter is in December. The intervening election is a confounding factor. While the Federal Reserve has been careful to articulate a framework for rate-cutting that is data dependent, they are unlikely to move before the election. Combined with the lesson of history and the economics literature, unless there is material weakness in the labor market in the next two employment reports, a September rate cut may not be a foregone conclusion.
Bottom Line: Recent research shows that stamping out inflation requires persistence, even in the face of growing risks to economic growth and employment. Taming the last mile of inflation may well require putting both at risk – and that may mean most observers are wrong about a September rate cut.