Will the Fed Acknowledge Reality?

Later today the Federal Reserve will announced results from its last policy meeting of the year. Will Fed Chair Powell declare victory over inflation and call an end to the interest rate tightening cycle? I think so.

Data released yesterday by the Bureau of Labor Statistics (BLS) confirmed Inflation continues to slow. The Consumer Price Index (CPI) picked up slightly in November from the prior month, but compared with a year ago prices are up only 3.1%. That’s one-third of the peak inflation rate back in the summer of 2022. Some categories—energy, apparel, appliances—are showing price declines (“disinflation”). On the other hand, prices for medical care and auto insurance are still rising at an above-average rate.

CPI’s estimate of rent inflation is also very high, but we know that measure is lagged—and I’d say contrived—making it less useful. CPI’s rent inflation rate is currently about 6.5%, whereas Zillow’s Rent Index is only 3.3% higher than a year ago. Other data sources agree that 6.5% is not realistic. Because rent makes up about one-third of the CPI, one has to wonder if the index is somewhat over-stated. CNBC reporter Steve Liesman spoke for investors when he said, “My concern is that a data-dependent Fed is making decisions on bad or at least outmoded data.” Stripping out rent, CPI is now well below the Fed’s 2% inflation target.

Also this week we also learned that wage growth has outpaced inflation for seven straight months. That’s because although wage growth is slowing, inflation has fallen faster. According to BLS data, average hourly earnings are up 4.0% from year-ago levels vs. CPI at 3.1%.

Finally, wholesale inflation—Producer Price Index (PPI)—also continued to slow last month. In fact, the PPI is less than 1% higher than it was a year ago. Excluding the more volatile categories of food & energy, so-called Core PPI is up a mere 2%. That’s the lowest rate since the beginning of 2021. Covid-related price pressure has evaporated.

What more evidence do we need that inflation is on pace to meet the Fed’s 2% target? Time is coming—and may already be here—when we need lower interest rates, not higher rates.