Wednesday’s inflation report put the markets and the Federal Reserve on notice that higher prices had yet to cool in June.
The headline number accelerated, rising by 1.3% on the month, as the core reading excluding food and energy continued its hot streak and advanced by 0.6%. The year-over-year pace for the Consumer Price Index rose to 9.1%, up from May’s 8.5% and March’s 8.6%, which had been the high in this cycle. The core CPI is up by 5.9% year-over-year; it’s a slight deceleration from May’s 6% and off the February-March peak rate of 6.4%.
There is a mixed message for the Fed, as the headline pace heats up but the core shows signs of being past its peak. Still, inflation in either measure is well beyond the Fed’s established 2% target, which applies to the PCE price index, which tends to be slightly cooler than the CPI. There is simply far too much inflation, too much momentum and a new peak rate in the CPI. Those facts will keep the Fed on its path to raise the federal funds rate by 75 basis points at its July meeting.
The report may even be enough to give rise to consideration of a full percentage point increase. Getting rates up higher and faster could put the Fed in the catbird’s seat later when inflation eventually breaks.
Still, the report harbors some disinflation hints that the Fed might want to stash in its policy pocket for later. But, for now, it’s mostly bad news on the front burner. No Fed official is going to want to tout any of the “good news” in this report and risk being labeled as weak on inflation.
Inflation spreads far and wide
In June, a broad array of food and energy categories rose by double digits year-over-year.
A good deal of attention centers on housing costs, where the rent of primary residence index was up to 5.8% in June from 5.2% in May. In November this measure was 3%. Owner-equivalent rent, which is an estimated cost of living imputed in the CPI for people who live in their own homes, rose 5.5% year-over-year, up from a 5.1% pace in May. That category continues to rise steadily.
While home-ownership costs are not high enough to be driving the headline CPI, they derive from factors where costs are going to continue to be tight. There is reason to be concerned that, looking ahead, these are important categories that could cause inflation to be sticky and hard to reduce to the 2% mark.
While the current pace of those indicators seems modest by comparison with the headlines, inflation is running well above the Fed’s 2% target for both measures. Those components are sure to move to the forefront of discussion about inflation and monetary policy, as conditions progress and as the headline figure loses some of its lift.
The computer-chip shortage has been a talked-about factor in the auto market, as shortages have driven up the price of used cars. In the June CPI report, used car prices were up only 7.1% year-over-year — a sharp break from gains of 16% to 41% dating to February. That is clear progress, but the pace of increases is still too strong.
Prices for new cars slowed only slightly to a 11.4% year-on-year from 12.6% in May and 13.2% in April. That is one of the categories that the Fed has been focusing on and expecting to show some relief when a supply chains begin to catch up with the production of computer chips. That relief seems in train, but it is not fully here yet.
Glimmer of hope
There is a glimmer of hope for disinflation in the tech sector, where a host of product categories are showing price declines rather than increases. There are five technology categories, ranging from communications to telephone services and various information processing areas where year-on-year prices fell in June. In four of those categories, prices fell over the 12 months ended in May and in three of them prices fell in April as well.
Before COVID struck, it was quite common for goods prices in the CPI to show declines while services prices had steady increases. We are now starting to see some of that trend return to the price index. Again, it’s some indication of progress but not enough to get policy to swerve.
No pyrrhic victory against inflation
It’s far too soon for the Fed to declare any kind of victory over inflation and probably too early to even speak constructively about the newest trends. Behind the scenes we do see a host of commodity prices that have been turning lower and energy prices that have broken from their peaks.
There are individual trends that the Fed is going to like. And there may be enough for the Fed to begin to think about slowing the pace and size of rate hikes after this month’s meeting.
However, monetary policy is going to be made meeting-by-meeting and report-by-report. The Fed will have to be very careful to ensure it has “the court of public opinion” on its side. This is not a time for the Fed to stick its neck out and take a chance by slowing its rate hikes early. After all, there is not enough “good news” in this report alone for the Fed to step back its pace of tightening.
Robert Brusca is chief economist of FAO Economics.