The Consumer Price Index for November 2023 showed that inflation continues to cool, but it may not be enough for the Federal Reserve to cut rates in early 2024 as the market anticipates. Headline inflation rose 0.1% month-on-month for November 2023 and 3.1% on an annual basis. That compares to the Fed’s 2% annual inflation target. When stripping out food and energy, which provides a less volatile measure of inflation, CPI saw a 0.3% month-on-month increase, or 4.0% on an annual basis. These figures were broadly in line with expectations from the Cleveland Fed nowcasts.
Underlying CPI Trends
The first trend is that U.S. inflation is clearly cooling and down significantly from the highs of 2021 to 2022. However, the question for the Fed is not if the economy is seeing lower inflation, but whether it is on track to return to the Fed’s 2% annual target. Here the Fed tends to analyze the constituent components of inflation.
Clearly, energy costs are falling, but the Fed tends to look through price swings there, even though that has helped lower inflation overall.
Shelter Costs
Next, shelter costs carry a high weight in the CPI series. So, price changes here are significant in moving the overall figures. Shelter costs were up 0.4% month-on-month for November and 6.5% annually. It’s likely shelter prices will need to cool further if inflation is to return to 2%.
So far, home prices have held up better than many expectations in the face of rising mortgage costs. It’s believed this is in part due to supply issues as those who locked in relatively cheap mortgages in recent years are looking to sell and see their mortgage costs rise significantly with a new home.
Goods Deflation
We’re now seeing the return of deflation in some goods, with the costs of apparel, new cars (though not used cars) and various foods, home goods and appliances falling in absolute terms month-on-month for November. This is helping bring down the overall inflation series. However, it remains to be seen how long this trend lasts.
Services Costs
The last major component the Fed tends to analyze is the cost of services. Here, prices have remained relatively high in certain categories as increased wages have fueled of service delivery costs. This applies to a range of diverse categories such as medical care, haircuts and funeral services. The Atlanta Fed’s Wage Growth Tracker reports annual wage growth of 5.2% for October. This somewhat parallels the housing trend in in that price growth is moderating but it remains higher than required for the Fed’s goal of 2% annual inflation.
Implications For Interest Rates
Inflation is generally moving lower. The question is: To what extent will the Fed ease up on interest rates prior to their 2% annual inflation goal being reached? The Fed may still be able to find fault with aspects of November’s CPI inflation figures as shelter costs and services remain elevated. However, this is increasingly offset by cooling prices elsewhere. Plus, separately, the jobs market and economic growth remain robust on recent reports.
Interest rates remain at restrictive levels. The Fed may still be able restrain prices from here without such high rates. In recent statements, the Fed has held the line on the possibility of further interest rate increases in certain circumstances. The market broadly disagrees that this will occur. Still, if inflation continues to cool, then the Fed may increasingly start to raise the prospect of rate cuts.