The cooling process of inflation in the United States is about to stall! The Fed's expectation of the end of interest rate hikes may add another variable?
Analysts pointed out that judging from the market's expectations for CPI, the cooling process of inflation in the United States is likely to stall before March next year, which is not good news for the Federal Reserve...
U.S. inflation may not fall much before March next year, adding new variables to the market narrative that the Fed may have finished raising interest rates.
Market-based annual headline CPI expectations suggest that there may be another six months above 3% starting with the October CPI data released on 14 November. If this is the case, then annual headline inflation will be at or above 3% for 10 consecutive months starting in June.
This prospect begs the question: How might Fed officials respond if price increases stabilize above the 2% target for a long time? Richmond Fed President Barkin said on Friday that his views on whether to raise interest rates again will depend more on inflation data than on a weak job market.
Gang Hu, a trader at WinShore Capital Partners, a New York-based hedge fund, said he expects Fed officials to "sit back and wait," just as the Fed kept interest rates above 5% for more than a year between 2006 and 2007 before cutting them.
"[At the time] the Fed spent a long time waiting for the economy to slow down after raising interest rates. It took a year and a half for the economy to slow down," Hu said. "Higher interest rates will take a long time to penetrate the real economy, and the Fed is willing to be patient at this point."
Headline inflation is important because it can influence households' expectations. But policymakers are more concerned with core indicators that exclude food and energy.
Hu said that based on his model and inflation traders' expectations, he expects core CPI to reach 0.27% m/m in October, down only slightly from 0.3% m/m in September and to remain around that level in the coming months. "For the Fed to raise interest rates again, inflation needs to accelerate to 0.3%, 0.4%, 0.5% month-on-month," he said. Hu estimates that core CPI should average 3% y/y over the next 12 months.
On Friday, the weaker-than-expected US non-farm payrolls report for October and the downward revision of the previous two months added credibility to the view that the job market is weakening. All three major U.S. stock indexes rose on Friday, with U.S. Treasury yields tumbling as investors hoped that a further weakening economy would bring inflation down.
At the same time, traders are not expecting a further decline in the annual headline inflation rate for a number of reasons.
One factor is that the health insurance business is expected to grow sharply starting in October, which will boost corporate profits and affect the way the U.S. Bureau of Labor Statistics measures inflation in the sector. In addition, traders are concerned that the recent strikes against automakers reflect "the superiority of labor over capital," Hu said. At the same time, they have not yet expressed their opinion on the possible impact of the Israeli-Hamas war.
For the Fed, "the target has changed," said Derek Tang, an economist at Monetary Policy Analysis in Washington, "when inflation is very high, the Fed is concerned that it won't come down fast enough." Now, they've made it clear that as long as inflation doesn't go up, they're okay with it, as long as they think it's going to come down at some point. ”
At his post-meeting press conference on Thursday, Powell said that removing the supply-demand distortions caused by the pandemic is a force that can bring down inflation without raising unemployment or slowing economic growth. One of the major advantages on the supply side is the significant expansion in the size of the labor market, which is due to the increase in labor force participation and immigration.
Given concerns about recession risks, policymakers are more likely to succeed in the battle on inflation, but "the problem is that the Fed is clearly very dependent on supply to get a lot of work done," Tang said. "They see an opportunity for a soft landing, so they don't have to hurt demand to achieve the low inflation they want. But the impact of these supply factors is limited and cannot last forever. We haven't entered a world with higher inflation expectations, but once those expectations change, it's too late. ”
"If inflation starts to rise from 3 percent, there is a risk that the Fed will fall behind again," Don said. It's one thing to be cheated once, it's not good to look at being cheated twice. ”