Pie-in-the-sky inflation narratives are crumbling one after the other. As the consumer price index report showed Thursday, inflation remains frustratingly elevated and broad, bucking the notion that it’s become concentrated in rents and a few other idiosyncratic categories — the latest convenient excuse among market doves and wishful thinkers. For better or worse, the problem runs deep, and the Federal Reserve won’t back off its interest rate increases until policymakers think they’ve weeded it out of the various nooks and crannies of the US economy.
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For the past year and a half, doves have repeatedly found novel ways to argue for less aggressive Fed policy. First, inflation was pinned on a jump in used-car prices. Then it was blamed on surging commodity costs after Russia’s invasion of Ukraine. Now there’s a growing proclivity to attribute it mostly to shelter, a heavily weighted CPI category that enters the index with a well-documented and significant lag relative to market prices.
Except it’s much more than that. Rent inflation is rising, of course, but the latest data also show that core inflation excluding shelter costs rose 0.5% in the latest monthly period. Looking at the change in the last three months, the adjusted index is rising at an annualized pace of 4.4% — not as bad as the 6% annualized rate of change for core overall, but still troubling, especially because the upward pressure is now stemming from sticky services-related categories. In the most recent months, prices have surged for myriad categories including pet services, car insurance and trash collection, among other examples.
The month-on-month diffusion index shows that 65% of the weighted share of the CPI basket rose last month at a 4% annualized rate or higher. Again, there’s been some improvement, but the problem is so wide and deep that you can’t discount a resurgence, especially if the Fed takes its eye off the ball. Inflation is moving from one category to the next like a game of whack-a-mole, and the policymaking voters on the Federal Open Market Committee have already quit their habit of torturing the data to justify high overall inflation, yet market participants apparently haven’t.
That doesn’t mean underlying inflation will stay as high as it has been recently, and indeed, most economists and Fed voters expect it to moderate meaningfully in 2023. But the latest numbers certainly validate the Fed’s stated path toward a federal funds target range of 4.5% to 4.75% at the end of 2023, including a 75-basis-point increase at the next meeting in the first week of November. Anna Wong, chief US economist at Bloomberg Economics, projects that the rate will reach 5%.
There’s also truth to the doves’ concerns about shelter inflation being yesterday’s news, but policymakers are already attuned to the issue. By design, CPI shelter inflation lags behind market pricing by a year or more, in part for technical reasons and because the data tries to capture the price of all rents paid, not just newly signed ones, meaning that most only reset once a year. The component makes up a whopping third of CPI overall, so it clearly has the potential to distort the top-line numbers. And if housing inflation were truly an outlier and the Fed were still pushing aggressive monetary tightening, that would indeed be a red flag. But for now, it’s not.
There are plenty of good reasons to worry about the Fed’s campaign, so you can’t blame the doves for trying. The first 3 percentage points of rate increases this year are still working their way through the economy, and there’s an elevated and rising possibility that the Fed’s aggressiveness will tip the US into a recession. If that happens, many people may reasonably believe that the inflation cure will prove worse than the disease — a debate we should have, even though it seems Fed voters have made up their minds. But there’s no sense playing down the problem in the first place. It isn’t just used cars, fuel or housing; it’s widespread, structural inflation, and it’s high time that everyone accepted that.
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