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CPI checks most of Powell’s boxes. Now what?


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The inflation story took a turn for the better on Thursday when the government reported that the consumer price index fell 0.1% from a month earlier. Policymakers at the Federal Reserve will play down the report’s significance and reaffirm their commitment to continue to combat volatile prices. But privately they should be elated.

Consider the situation from the Fed’s perspective. Less than two months ago, Chairman Jerome Powell laid out his framework for thinking about inflation in a speech at the Brookings Institution. Today, many of his hopes and dreams are already being realized. Supply chains are recovering and commodity prices are cooling, while market rent forecasts signal that housing inflation will also ease soon. (1) Perhaps most importantly, central bankers received encouraging evidence on essential services, excluding shelters—that all the important components of the wage-driven CPI that Powell feared would be most difficult to tame.

Indeed, after stripping out rent and owner-equivalent rent, the prices of basic services rose at an annual rate of just 2.6% over the past three months. When Powell gave his speech at Brookings, annualized quarterly inflation in that category was 7.1%. It is now essentially back to its pre-pandemic average.

Even before Thursday’s report, there was growing evidence that inflationary pressures were easing in core services outside of housing. Institute for Supply Management report 6th of January showed that prices paid by service providers fell for a second month. Meanwhile, gains in average hourly earnings — which Powell noted as a major potential driver of prices in the service sector — have moderated significantly. While wage growth is above pre-pandemic norms in both the goods and services sectors, the latter has suffered a sharp decline.(2)

Of course, Powell and his colleagues will continue to argue that inflation remains “too high,” but that’s something of a rhetorical stunt. If traders sniff out lower inflation and the end of interest rate hikes, markets will pick up even more, so bond yields and borrowing costs will fall, and — in the Fed’s view — that could revive inflation. In a technical but misleading sense, it is true that the Fed has yet to meet its 2% inflation target. As of the latest report, the annual change in the core consumer price index stood at 6.5%. That should leave the Fed’s preferred gauge of inflation, the personal consumer spending deflator, at about 4.7%, according to Bloomberg Economics calculations — well above the 2% target. The Federal Reserve is likely to raise interest rates by an additional 50 basis points or so to make sure it gets the job done.

But in a practical sense, the central bank is not really missing its target by much, and a change in policy is very important towards the end of the year. Changes in the consumer price index, measured over the year, are heavily subject to main effects, meaning they say as much about where prices were in December 2021 as they do in December 2022. Prices are not rising right now a lot. Based on core consumer price index data over the past three months, the annual inflation rate was just 3.1%. Using headline inflation, prices rose by just 1.8%.

Clearly, there are some flaws in the report – that the cooling in the CPI shelter has yet to really materialize despite the leading indicators – but there is no doubt that the overall inflation picture looks bright. Not only that, but this is the third report in as many months to support this conclusion, meaning it’s probably not a fluke. Bond markets took note, with the yield on the two-year Treasury note falling six basis points to 4.16%, heading for its lowest close since Oct. 5. The S&P 500 fell slightly, understandably because lower inflation does not rule out a recession and an accompanying drop in earnings. Higher interest rates take a while to bite and often with severe and unintended consequences.

Another spike in prices like the one that happened in the late 1970s after Federal Reserve Chairman Arthur Burns thought he had beaten inflation in 1976 is certainly possible. We can’t rule out the idea , that there are larger structural problems here, they are calling for a long-term war on inflation. But using Powell’s own criteria, there’s little doubt that this particular battle is almost over — no matter what the Fed chairman and his colleagues end up saying publicly.

More from Bloomberg Opinion:

• A soft landing won’t mean the economy is safe: Alison Schrager

• Is 2% inflation in sight? Be careful what you wish for: John Otters

• Who’s Afraid of the Big Break for a Bad Rate?: Daniel Moss

(1) Shelter inflation enters the CPI with a well-known lag relative to market prices, but alternative data from vendors such as Zillow suggest that shelter inflation should ease soon.

(2) The Bureau of Labor Statistics’ jobs report last week showed that average hourly wages at private sector service companies rose at a 4.1 percent annual rate based on data from the past three months. The average before the pandemic was around 3.4%. Of course, lately the data has been erratic and sometimes misleading. Before the latest revisions, the same data series appeared to be accelerating in November. A firmer verdict on the state of wage pressures will come from the more reliable BLS employment cost index, which is published quarterly and will be updated next on January 31, the day before the Fed’s next interest rate decision.

This column does not necessarily reflect the views of the editorial board or Bloomberg LP and its owners.

Jonathan Levin worked as a journalist at Bloomberg in Latin America and the US, covering finance, markets and mergers and acquisitions. Most recently, he served as the company’s Miami bureau chief. He is a chartered CFA holder.

More stories like this are available at bloomberg.com/opinion


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