Peak Inflation Watch: October 14, 2022
If we are generous, the arguments in favor of a spike in inflation are mixed. Depending on the indicator chosen, there is supporting evidence to decide that the worst of the inflationary spurt is behind us. But there is also data to claim otherwise, such as yesterday’s update on consumer prices recalls.
The CPI figures for September are a mixed study. The headline CPI continues to show an inflation spike in the rear view mirror, albeit modestly, but core inflation continues to hit new highs. The Federal Reserve focuses on underlying inflation for several reasons, including empirical evidence that it tends to offer a better estimate of the trend compared to the higher short-term volatility of its global counterpart. On this basis, the continued rise in the core CPI is another warning that inflationary pressures have not yet peaked.
Core CPI reached 6.6% on an annual basis (in unadjusted terms) through September, slightly surpassing the previous high in March and hitting a 40-year high.
“That’s not what the Fed wants to see six months into one of the most aggressive tightening cycles in decades,” said Sal Guatieri, senior economist at BMO Capital Markets.
The CPI report suggests that the Fed will continue to raise rates aggressively. Fed Funds Futures are currently pricing with near certainty another 75 basis point hike at the next FOMC meeting on November 2.
“There is a persistence of inflation which, if you are the Fed, must be deeply worrying,” said Ajay Rajadhyaksha, Global Research Chair at Barclays. “Most people feel like we’re about to turn, whether it’s on jobs or on inflation, and it’s not happening and it’s not happening and it’s not happening.” The Financial Times reports that Rajadhyaksha expects the Fed to extend rate hikes by 0.75 percentage points until the end of this year and start to slow the hikes to an increase of 0.50 percentage points at the first meeting of 2023 in early February.
Is the case of peak inflation dead? No, at least not entirely, although the timing remains unclear. There are many encouraging signs, ranging from easing tensions in major supply chains to more moderate price increases for some shipping costs. Michael Pond, Head of Global Inflation Research at Barclays, predicted the signs of a spike in inflation will strengthen in the coming months.
Wage inflation suggests so. The annual increase in the average hourly wage of all employees in the private sector has recently fallen, slipping to 5.0% through September, the slowest this year.
But the recent discrepancy between core CPI and headline CPI measurements remains very clear, which argues in favor of a reserve of judgement. Profiling the data via CapitalSpectator.com’s Inflation Bias Indices shows this clearly thanks to the recent rally in core CPI. It is unclear if this is noise that will soon resume the downward bias that had been persistent until recently. (The methodology takes a standard inflation index, calculates the change over one year, then calculates the monthly difference and transforms the results into standard deviations around the mean. This measure offers a way to develop quantitative information to decide in which sense the inflationary wind is blowing.)
An alternative (and arguably more robust) set of consumer inflation measures gives stronger arguments for expecting the inflation bias to be consistently higher (based on examination of the data via CapitalSpectator.com’s inflation bias methodology mentioned above). Three of these four measures indicate an upward bias for inflation.
As I noted in last month’s review, alternative measures of inflation continue to suggest that high inflation seems more entrenched, which will likely prompt the Federal Reserve to raise rates for longer, and perhaps be more than expected recently. That was true a month ago and it remains true after the September data release.
Nevertheless, relief may be near, albeit for not very comforting reasons. As I reported last week, the economy looks set to fall into recession from November. If correct, a healthy dose of inflation taming may be at hand. It’s a harsh dose of medicine, but history suggests it almost always works…eventually.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.