Time for the Fed to Declare Victory Over Inflation? not but

A man pumps gasoline at a gas station in the Brooklyn borough of New York, the United States, December 13, 2022.

Michael Nagel | Xinhua News Agency | Getty Images

December’s monthly decline in CPI brings the Federal Reserve a step closer to fighting inflation, although they are highly unlikely to signal an easing of monetary policy any time soon.

The key inflation indicator fell 0.1% for the month, in line with market expectations and the biggest drop since April 2020.

Though CPI for all items is still 6.5% up from a year ago, the arc has been steadily lower — since peaking at about 9% per year in June 2022 — amid a sharp fall in gas prices and some severe rate hikes the fed

The question now is how much evidence policymakers need to see before they take their foot off the brakes.

“If they’re forecasting what they should be doing, it strongly suggests their rate hikes should come to an end soon,” said Mark Zandi, chief economist at Moody’s Analytics. “There is nothing wrong with this report. Inflation will come [down] here.”

Dean Baker, senior economist at the Center for Economic and Policy Research, was even more emphatic. In a tweet, Baker insisted that “it’s time for the Fed to declare victory and halt the rate hikes!” He cited a three-month decline in services inflation minus accommodation costs as evidence inflation is on the run.

But considering how aggressive central bankers have been since initiating rate hikes in March 2022, and how cautious they have been about viewing isolated data points as part of a broader trend, the likelihood of taking the win now seems slim.

After all, both headline and core inflation (excluding food and energy) — up 0.3% for the month and 5.7% for the year — are still well above the Fed’s 2% target. Chairman Jerome Powell recently said that the inflation component of non-accommodation services is a key consideration as rental costs are likely to come down later this year.

But he and his colleagues have also stressed the importance of maintaining vigilance, and have said they see more danger in easing than further hard pressure, even if it means the economy comes close to grinding to a halt .

“Goldilocks” on the horizon?

What the central bank is now aiming for is a robust labor market that has withstood higher interest rates. But that’s both a blessing and a curse, as wages have continued to rise and threaten to push up inflation.

“If you can bring inflation down without destroying the job market, that’s Goldilocks’ soft landing,” said Randy Frederick, Charles Schwab’s managing director of trading and derivatives. “That’s roughly what we saw in the data we got last week and today’s inflation.”

The December non-farm payrolls report showed a solid rise in jobs by 223,000 and a year-on-year decline in average hourly wage growth to 4.7%. Frederick expects the Fed to record the data but not commit to a policy change at its next 1/31 meeting.

“They will appreciate that the data has improved what they have. But I don’t think they want to put their hand on what’s going to happen in six weeks,” Frederick said, referring to the following Federal Open Market Committee meeting 15-16. March.

According to CME Group, markets are pricing in a near-certainty — 93.2% as of Thursday lunchtime — that the FOMC will again scale back the level of its Feb. 1 hike to 0.25 percentage point. The expectation is for another quarter point in March, then a pause before the committee cuts up to half a percentage point from the fed funds rate by year-end.

Philadelphia Fed President Patrick Harker said Thursday he supports the Fed moving down to quarter-point increments and then pausing. Its policymakers have firmly stated that they do not expect any rate cuts in 2023.

But the market acts differently.

The hike after the March meeting will give the FOMC time to consider the impact of all hikes, which will total nine and total 4.75 percentage points if market prices are correct.

What is not expected is a premature signal of a victory over inflation.

“I don’t think they’re close to announcing victory,” said Simona Mocuta, chief economist at State Street Global Advisors. “They will be very careful about verbalizing this even though they may downshift [a quarter-point hike], which acknowledges the improvement of the data. But I wouldn’t expect the tone and language coming out of the committee to change dramatically for any length of time. They believe it’s better to be safe again.”

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