Tomorrow, the Federal Reserve will wrap up its 2-day monetary policy meeting. No one expects them to take any action on interest rates this time around, especially given higher than expected inflation readings to start the year. Rather than what the Fed is doing, we’re interested in what they’re saying. An update to the Fed’s quarterly Summary of Economic Projections should give us insight into how Fed officials are viewing the disappointing price data and how many rate cuts are still on the horizon for 2024. Just as important will be Chair Jerome Powell’s post-meeting press conference.
Here’s what Powell and his colleagues are seeing. The Consumer Price Index surprised to the upside last Tuesday. Inflation rose to a 3.2% annual rate, up from the prior month’s reading of 3.1%. Core prices rose 3.8% year-over-year.
The short-term readings are even worse. On a 3-month annualized basis, headline CPI rose 4% and has remained stubbornly above the Fed’s 2% for the last 18 months. 3-month annualized core CPI climbed to its highest level since last May.
And with commodity prices moving higher to start the year, rising input costs should be top of mind for the price-focused setters of monetary policy. The Fed absolutely can’t afford to let prices reaccelerate - not with how adamant they’ve been about fulfilling that half of their dual mandate - and that forces them to keep a tight rein on economic activity through a policy of higher interest rates for longer.
We can see the impact higher inflation readings have had on the market. Back in mid-January, the market was pricing in as many as seven 0.25% interest rate cuts in 2024, based on implied interest rates for December. Today, we’re looking for just 3.
Fortunately for the Fed, they’ve got one thing working in their favor on the inflation front. CPI excluding shelter has been below the Fed’s 2% annual inflation target since June. On a 3-month annualized basis, this measure of prices has been subdued since October 2022.
If shelter inflation continues to normalize, following the path of home prices and rental rates, that should help offset the impact of energy prices.
Unfortunately, complete normalization of shelter costs - which comprise a third of the CPI - will take time. And the longer interest rates remain elevated, the higher the risk of tight policy tipping the economy into recession.
Consumption has slowed significantly to start the year. In January, retail sales dipped into negative territory compared to the prior year. Over the last 20 years, that’s something we’ve only seen during recessions.
Poor January weather and a pull-forward of demand in December are being blamed for the weak reading, but better weather in February didn’t lead to much of a rebound. We’ll remind our readers that weather is like alcohol - it gets blamed for a lot of things it didn’t do.
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