The market celebrated the June monthly CPI data. Headline CPI came in at just 3.0% YoY – and Core CPI fell to 4.8% YoY. Good news. However, with Core CPI still more than 2x the Fed’s target – expect them to raise rates again at the end of the month. However, what surprises me is the market believes the war with inflation is basically done. Is it? I think that is presumptuous. The fight with Core inflation will be a long one. If correct, the Fed may not need to keep raising rates aggressively – however are likely hold them there until their objective is met.
Fed Reserve
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Fed Minutes Suggest More Hikes
Today the Fed released this statement from their latest minutes “The economy was facing headwinds from tighter credit conditions, including higher interest rates, for households and businesses, which would likely weigh on economic activity, hiring, and inflation, although the extent of these effect remained uncertain”. But here’s the thing: the market could be underestimating how long the lag effect is. Typically it’s between 12 and 24 months. However, with an extra $2+ Trillion in (perhaps wasteful) government handouts, that has softened the blow dealt from higher rates. But make no mistake – the lag effects from 500 bps of tightening will come – it’s just longer than expected.
‘Higher for Longer’ after May Core PCE
May’s print for Core PCE came in 4.6% YoY – still well above the Fed’s objective of 2.0%. However, mainstream were quick to label the report as ‘lackluster’. Why? Here’s the thing – Core PCE has hardly changed the past few months. It dipped in May to 4.62%, from April (4.68%), but was above March (4.61%), and was exactly where it had been in December (4.62%). Put another way – we have made no ground since December – and yet it was now somehow ‘lackluster’. But it gets better: core services inflation (without energy services) rose by 5.4% in May YoY. It was fractionally lower than April (5.5%) – but equal to what we see in both March and December (5.4%). Similar to Core PCE – it too is stuck in a tight range for 5 consecutive months. What does all this mean? Simple: rates will be higher for longer and markets don’t get it.