Inflation in the United States meets almost all of Powell’s expectations. Whats Next?

Put yourself in the shoes of the Fed. Less than two months ago, Chairman Jerome Powell laid out his analysis of inflation in a speech at the Brookings Institution.

Today, most of your dreams and hopes are coming true. Supply chains are picking up and prices for basic goods are cooling.

Perhaps most importantly, central bankers have received encouraging evidence regarding basic services excluding housing: that major wage-based CPI component that Powell feared would be the hardest to tame.

In fact, after excluding rent and the equivalent rent from owners, the prices of basic services have increased in the last three months at an annualized rate of only 2.6%. When Powell gave his speech at Brookings, annualized quarterly inflation in that category was 7.1%. Now, it’s pretty much back to its pre-pandemic average.

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Even before Thursday’s data, there was mounting evidence that inflationary pressures were easing in basic services outside of housing. A January 6 report from the Institute for Supply Management (ISM) showed that the measure of prices paid by service providers declined for a second month.

Meanwhile, increases in average hourly earnings, which Powell has pointed to as the main potential driver of service sector prices, have moderated significantly. While wage growth is above pre-pandemic norms in both the goods and services sectors, the latter has experienced a sharp decline.

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Of course, Powell and his colleagues will still argue that inflation is still “too high,” but this is something of a rhetoric. If traders spot lower inflation and an end to interest rate hikes, markets will rally further so bond yields and borrowing costs will fall and, in the Fed’s view, that could be revived. inflation.

In a technical but misleading sense, it is true that the Fed is still missing its 2% inflation target. With the latest report, the interannual variation of the general consumer price index stands at 6.5%. That should leave the Fed’s preferred inflation gauge, the personal consumption spending deflator, at around 4.7%, according to Bloomberg Economics calculations, well above the 2% target. To make sure it gets the job done, the Fed will probably raise interest rates an additional 50 basis points.

There are obviously some blemishes in the report, that the haven CPI cool has yet to really materialize despite the indicators, but not only that, but this is the third report in as many months to support that conclusion, which means which is probably not a fluke.

Bond markets have taken note, with the yield on the two-year Treasury note falling six basis points to 4.16%, putting it on track for its lowest close since Oct. 5. The S&P 500 index fell slightly, which is understandable, because lower inflation does not rule out a recession and a consequent drop in earnings. Higher interest rates take time to kick in and often have harsh and unforeseen consequences.

There are obviously some blemishes in the report, that the haven CPI cool has yet to really materialize despite the indicators, but not only that, but this is the third report in as many months to support that conclusion, which means which is probably not a fluke.

Bond markets have taken note, with the yield on the two-year Treasury note falling six basis points to 4.16%, putting it on track for its lowest close since Oct. 5. The S&P 500 index fell slightly, which is understandable, because lower inflation does not rule out a recession and a consequent drop in earnings. Higher interest rates take time to kick in and often have harsh and unforeseen consequences.

To be sure, another price rise is possible, like the one that occurred in the late 1970s after Fed Chairman Arthur Burns thought he had outpaced inflation in 1976.

We cannot dismiss the idea that there are larger structural problems at stake that call for a protracted war on inflation. But using Powell’s own standards, there is no question that this particular battle is about to end, regardless of what the Fed Chairman and his colleagues say in public.

By Jonathan Levin