A slowdown in US inflation may be short-lived as the risk of unexpected price spikes is rising, throwing doubt on whether the Federal Reserve’s rate hikes are truly over.
The overall consumer price index increased 3.2% from July 2022 to July 2023 before a seasonal adjustment, the US Bureau of Labor Statistics reported Aug. 10. The index increased less than 0.2% from June to July, roughly the same increase from May to June and the smallest back-to-back increase since February 2021.
Consumer price growth has drastically slowed from its 2022 peak, though some measures of inflation sit well above the Federal Reserve’s policy target of 2% annual gains. Rising energy prices in August, meanwhile, are expected to add renewed pressure on inflation that will likely filter through to central bank monetary policy decisions.
“The key caveat here is that inflation has to stay on a clear and persistent downward trend,” said Oren Klachkin, a US economist at Oxford Economics. “The Fed won’t hesitate to hike again if inflation surprises to the upside.”
End of declines?
Some of the biggest contributing declines were from the energy sector, which makes up about 7% of the index. Gasoline, for example, fell by 19.9% from July 2022 to July 2023, as the overall sector saw a 12.5% decline.
But those declines are unlikely to stretch into August, as crude oil futures prices have already climbed to their highest level since November 2022. The average price of a gallon of regular gasoline in the US has jumped nearly 30 cents in a month to $3.83, according to AAA data as of Aug. 10.
The “long string of negative contributions to headline inflation from falling crude oil prices is about to end,” said Joel Prakken, chief US economist with S&P Global Market Intelligence.
In addition, the significant declines in airline fares, which fell 13.2% from August 2022, are unlikely to be maintained, Prakken said.
“Inflation has made a lot of progress, but it could get stuck at these levels if growth picks up,” said Callie Cox, a US investment analyst at eToro.
The rise in gasoline prices along with expected growth in credit card spending could push inflation up in August, said Edward Moya, a senior market analyst with OANDA. US credit card debt jumped to a record $1.031 trillion in the second quarter of 2023, up from $887 billion in the second quarter of 2022, according to the latest data from the Federal Reserve Bank of New York.
“There is too much resilience in this economy for the disinflation trends to continue to take prices to the Fed’s 2% target,” Moya said.
The approximately 20% increase in oil prices is clearly an upside risk for inflation, but broad disinflation appears likely to continue, said Gurpreet Gill, a global fixed-income macro strategist at Goldman Sachs Asset Management.
Goods prices will likely further ease as supply chains and demand normalize and used car prices, which have had an outsized impact on US inflation data, will likely decline further, Gill said.
“Importantly, labor market rebalancing is slowly but surely progressing,” Gill said. “This should help to alleviate core services price pressures despite the slight tick higher in July.”
The last hike?
Fed officials have signaled that rate hikes are likely over and about three-quarters of the futures market believes that the federal funds rate will end this year at its current level or lower, according to the CME FedWatch Tool, which measures investor sentiment in the fed funds futures market.
Yet whether the Fed is done hiking this year, after increasing its benchmark interest rate by 525 basis points since March 2022, remains up for debate.
Prakken with Market Intelligence, for example, sees one more rate hike in November.
“Powell has said it will take ‘credible evidence’ that inflation has ‘topped out’ for the Fed to stop raising rates,” Prakken said. “I think we’re pretty close to that.”
The Fed will not raise rates for the remainder of this year, but that could quickly change if core inflation readings, which do not include volatile energy or food prices, start to show some red flags, Moya said. Core CPI increased 4.7% from July 2022 to July 2023, down from the 6.6% peak in September but still well above the Fed’s 2% target.
Fed officials likely view the latest inflation data as “one more step down the disinflationary path,” Lydia Boussour, a senior economist at EY-Parthenon, wrote in an Aug. 10 note.
“But with inflation still far from its 2% destination – the [Federal Open Market Committee] will likely maintain a hawkish bias and keep the door open to further rate hikes if the data justifies it,” Boussour wrote.
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