U.S. headline inflation has come down sharply from peak levels of summer 2022, but not yet enough for the Federal Reserve who are still planning further interest rate hikes. Will the remainder of 2023 reassure the Fed on inflation, or not?
Nowcasts
Nowcasts of inflation from the Cleveland Fed suggest that July’s CPI inflation may be less encouraging, than June’s data, with headline inflation showing an estimated 0.35% monthly increase and core CPI seeing a projected 0.4% monthly rise. These nowcasts combine the latest energy pricing data with other price and inflation metrics. July’s nowcast would represent a material spike over June’s monthly 0.2% rise for both series, if these forecasts hold.
However, in recent months such inflation nowcasts have tended to overestimate inflation. Nowcasts look at the latest pricing and so aren’t able to forecast further out into 2023 beyond the current month. Still, if the nowcasts for July hold, then the Fed’s concern that June’s CPI reading could just be a single encouraging datapoint, may hold true.
Producer Prices
Wholesale prices can be a leading indicator of consumer prices, and the Producer Price Index captures this. As of June headline producer prices have risen just 0.1% over the past 12 months, which is encouraging for consumer inflation. However, if you strip out food and energy then the increase is higher at 2.6%, but still closer to the Fed’s inflation target than the current rate of core CPI inflation.
Wage Trends
The Fed is particularly concerned about inflation in services. That’s really the last component of inflation left running worryingly above trend, as good prices have moderated and home prices appear to be softening too, at least when compared to recent steep price increases.
Here the Atlanta Fed’s Wage Growth Tracker, has wages rising at a 5.6% annual rate for June 2023. That’s relatively high, but the series has declined from higher levels since July 2022, albeit the decline is relatively shallow.
Energy Costs
Energy costs can see big swings which move overall inflation. Currently oil remains materially lower than this point in 2022, but is above the lows of June 2023, and natural gas, though more seasonal, has seen steep declines too. This continues to help move inflation lower, and if prices hold around current levels, energy costs may continue to help bring inflation lower to late 2022. Nonetheless, the Fed likes to strip out energy swings in its assessment of inflation trends, so the Fed may be less focused on energy prices as it considers interest rate decisions.
Housing
Perhaps the most encouraging trend for CPI inflation might be housing costs. In June these rose at a 0.4% monthly rate and shelter costs appear to be slowing over 2023 so far. If this trend continues, and there’s reason to suspect it may given how shelter costs are tracked in the CPI series, then this could help move inflation lower in the coming months. This is important because housing carries a large weight in the CPI series.
Base Effects
Inflation is a 12-month rate of change in prices. Hence each month one new month of data is added, and a month of data from a year ago drops out of the series. Often it’s a lot easier to see how what’s leaving the series will impact inflation than what the new data will hold. For the first half of 2023 a lot of high inflation figures left the series. March, May and June 2022 all saw CPI inflation rise 1% in each month. As those high numbers have rolled out of the inflation series, so inflation has declined.
Unfortunately the second half of 2023, doesn’t offer the same benefit. Inflation was much more subdued in the second half of 2022 than the first half. In fact, the range of inflation readings for the second half of 2022, aren’t dissimilar to the monthly inflation in the first of 2023, and so big inflation numbers rolling off the series won’t offer a tailwind to bring inflation lower. That said, inflation too is running at a lower rate than in early 2022.
Of course, inflation can still move lower, but if it does it will be fueled more by flat or declining current prices than by large increases rolling off the series from earlier periods.
What To Expect
A lot could change in the second half of 2023. Inflation is unlikely to decline as abruptly in the second half of 2023 as in the first, but it doesn’t need to as it’s now closer to the Fed’s goal.
For many the key issue remains services prices and that’s what the Fed will be watching most closely. However, home prices and perhaps energy costs too should help inflation continue to move down on current trends.
Whether that proves sufficient for the Fed to adjust course on interest rates remains an open question, but for now the expectation is the Fed may want to keep rates at high levels until evidence of lower inflation comes through. We’ll receive July’s CPI numbers on August 10.