Following the May CPI release on June 12, 2024, here is an inflation update. The significance of the figures and their influence on Fed policy are discussed. Economists concede that inflation means higher prices.
In our opinion, the most important development this year is not the apparent “disinflation,” but the fact that most economists are coming to terms with the general public’s understanding of the difference between falling inflation and falling prices. After all, the Fed correctly refers to “price stability” rather than “inflation stability.”
“In May, the Consumer Price Index for All Urban Consumers was unchanged, seasonally adjusted, and rose 3.3 percent over the last 12 months, not seasonally adjusted.” The updated chart is below.
Here are some insights gleaned from the chart above:
- The CPI is rising on a new uptrend that started in March 2021, 12.2% above the old trend that started after the GFC.
- A reversion to the old trend is not possible. The objective is to slow the rate of increase. Returning to the old, pre-pandemic level requires a significant deflation, worse than the one that occurred during the GFC.
- The 12-month rate of change of CPI, or YoY, has moved sideways for nearly a year. We believe the Fed fears that inflation might have become entrenched. This is a low-probability scenario but nonetheless a possibility. In this case, do not expect material rate cuts for maybe one more year.
- Since March 2021, when the YOY CPI moved above 2%, which amounts to a period of 39 months, inflation has been at 19.5% and is on an uptrend. This is our indicator of when the Fed will cut. Specifically, we believe the Fed will not cut if inflation has remained above 18% since March 2021.
Note that the Fed may cut 25 basis points to measure the market reaction, and if inflation starts reaccelerating, they may raise rates significantly, even by 50 or 75 basis points. Therefore, anyone pushing for that small cut should know what they want. The Fed will maintain its credibility by asserting that it not only responded to stimulate the economy, but also took proactive measures to combat inflation. Under the current pressure regime to lower interest rates before elections, we do not think there will be any credible accusations of the Fed re-igniting inflation after a cut.
Finally, many analysts believe that the inflation game is about economics, or even econometrics. In reality, this is a complex political, socioeconomic, and geopolitical game. The last thing the Fed wants at this point is to see the US dollar drop hard. That will disturb the stability of the financial markets. They will try to find a formula to weaken the dollar while asset prices rise. This may be challenging under the current regime. Therefore, the US dollar level is a constraint on policy at this point in time.
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Specific disclaimer: This report includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
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Charting and backtesting program: Amibroker. Data provider: Norgate Data
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