US inflation continues to decline, but wages will keep the Fed on its toes

The Federal Reserve’s preferred inflation gauges cooled in November, including a headline annual measure that posted the smallest rise in more than a year, according to Commerce Department data released Friday. Consumers’ annual inflation expectations fell this month to the lowest level since June 2021, a University of Michigan survey showed.

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Yet wages continue to rise too fast for the Fed’s liking. While the central bank is nearing the end of its interest rate hike cycle, data suggests borrowing costs will remain high for a period of time. prolonged until policymakers are more confident that price pressures are on a sustained downward trend.

Inflation-adjusted consumer spending leveled off in November, but officials will want to see more than a month of data indicating demand is cooling substantially.

“Overall, the data releases painted a picture of a slowing economy towards the end of the year, which should help support a continued slowdown in inflation as we head into 2023.”said Sam Millette, fixed income strategist at Commonwealth Financial Network, in a note.

After hitting 40-year highs earlier in the year, price pressures are finally easing. The Personal Consumption Expenditures Ex-Food and Energy Price Index, which Fed Chairman Jerome Powell has highlighted as a more accurate measure of where inflation is headed, rose 4.7% in November, up from 5 % of the previous month.

The general PCE price index rose 0.1% and 5.5% more than a year ago, the lowest since October 2021, but still well above the central bank’s 2% target.

While that should be good news for Powell and his colleagues, wage gains, particularly in the service sector, have remained stubbornly strong. Inflation-adjusted disposable income increased by 0.3%. Wages and salaries, without adjusting for prices, rose 0.5% for a second month, Commerce data showed.

While that has been a boon for American workers, officials see it as potentially worrying about the trajectory of price increases. Powell has focused on compensation as a guide in the central bank’s fight against inflation, which may support why the Fed sees borrowing costs as staying higher than investors.

“The incoming data continues to paint an economy that has not cooled enough to reduce inflation that is too high”, Citigroup Inc. economists Andrew Hollenhorst and Veronica Clark said in a note. “While the pressure on goods prices has eased along with demand, we don’t see a similar dynamic in services.”

What Bloomberg Economics Says…

“The November slowdown in the Fed’s preferred price measure, the PCE deflator, adds to evidence of near-term downward momentum for inflation…Nonetheless, strong wage earnings and real incomes They suggest that the job market has yet to cool significantly, and officials are unlikely to see this report as convincing enough to make them back away from a terminal federal funds rate above 5%. —Anna Wong and Eliza Winger, economists.

Other parts of the economy are showing more noticeable impact from the Fed’s most intense tightening cycle since the early 1980s, separate government data showed on Friday.

Orders placed with US manufacturers of non-defense capital goods, except aircraft, rose 0.2% in November after a sharp downward revision from the previous month, and total durable goods stocks plunged a 2.1%, the biggest drop since April 2020.

The housing market, which is particularly sensitive to changes in interest rates, may be stabilizing as mortgage rates recede from a two-decade high. New home sales rose unexpectedly in November for the second month, although the data is extremely volatile.

“I suspect builders are much more motivated sellers (especially given rising financing costs) than current homeowners, who don’t want to part with their mortgages at 3% or less”said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC. in a note “This may explain why new home sales are rising while existing home sales are plummeting.”

Consumers are increasingly optimistic about the path of price pressures, with short-term and long-term inflation expectations falling this month, data from the University of Michigan showed. That reflected easing price pressures and relief at the gas pump, which boosted confidence, but the data reflects a high degree of uncertainty.

“While sentiment appears to have turned around from its all-time low in June, its trajectory, as well as that of consumer spending, will depend on the strength of labor markets and incomes”said Joanne Hsu, director of the survey.