Weekly Economic Trends and Indicators
The Headline:
Last week the market received a slew of information from the Bureau of Labor Statistics on inflation, and the news was good all the way around. The consumer price index (CPI) was unchanged in October. The producer price index (PPI) for final demand decreased by 0.5% in October. Finally, import prices fell by 0.8% in October. The collective impact of these three data points sent the financial markets sharply higher throughout the week on hopes that we may have turned the corner on inflation.
The Details:
While the headline CPI looks good, it is being driven by a drop in energy prices that is balancing out the continued increase in shelter prices. Given the volatility of energy prices, this could quickly reverse. The story is the same for the PPI and import prices. Lower energy prices were the key. Also of note was a drop in the price of goods sold by U.S. exporters, which could help export sales in this quarter and provide some relief from the strong value of the dollar.
The Context:
There is no denying that the news on inflation last week was very positive—perhaps the best news on inflation that we have had in this cycle. Many analysts would not have predicted this kind of progress just a few months ago. There has been much skepticism as to whether it would be possible to bring inflation down this far, this fast, without causing a spike in unemployment.
Does this mean that the Federal Reserve is really done raising the Fed funds rate? The market clearly thinks so, but there is no guarantee. According to the CME FedWatch Tool, the probability of a rate increase (or decrease) in December is effectively zero. The probability of a rate increase had been nearly 40 percent as recently as Nov. 10. That is how far the market moved on the strength of this inflation data. Looking further out, the market now prices in a 30% chance of a rate cut by the March Federal Open Market Committee meeting.
However, Cleveland Federal Reserve Bank President Loretta Mester said in an interview with CNBC, “We’re making progress on inflation….We’re going to have to see much more evidence that inflation is on a timely path back to 2 percent.” Indeed it would be premature to declare victory over inflation at this point. Fed Chair Jerome Powell has taken great care to send the message throughout this cycle that it takes more than one good data point to show a definitive change in the trend.
While this is certainly good news, the risk of policy error (as discussed in our most recent Quarterly Market Report) still exists. Lower inflation with the same nominal interest rate means that real interest rates are rising, contracting the economy further. Failing to cut interest rates when inflation is coming down would be making the same mistake as raising them too high. Productivity is the variable to watch in the coming weeks to see if the Fed has room to cut rates.
Next week: Energy price outlook
