People shop at a store in Brooklyn, New York on August 14, 2024.
Spencer Pratt | Getty Images
The Federal Reserve will take a final look at inflation measures this week before deciding soon on the size of a widely expected interest rate cut.
On Wednesday, the Department of Labor’s Bureau of Labor Statistics will release its Consumer Price Index report for August. The next day, the Bureau will also release its August Producer Price Index report, a measure used as a proxy for costs at the wholesale level.
The question of whether the Fed will cut interest rates at its next policy meeting on September 18 is effectively settled, with the only remaining question being how big a cut it will be. Friday’s employment report did little to provide a clear answer on this issue, so hopefully the release of the Consumer Price Index (CPI) and Producer Price Index (PPI) will provide some clarity.
“Inflation data trails labor market data in terms of its impact on Fed policy,” Citigroup economist Veronica Clark said in a note. “But with markets, and likely Fed officials themselves, divided on the appropriate size of the first rate cut on Sept. 18, the August CPI data could remain an important factor in any upcoming decisions.”
Dow Jones consensus forecasts are for the CPI to rise 0.2% for both the all-item measure and the core measure, which excludes volatile food and energy items. On an annualized basis, inflation is expected to be 2.6% and 3.2%, respectively. The PPI is also forecast to rise 0.2% for both the headline and core measures. Fed officials typically favor the core measures as they are a better indicator of long-term trends.
At least for the CPI, that number isn’t particularly close to the Fed’s long-term target of 2%. But there are some important caveats to keep in mind.
First, while the Fed is paying attention to the CPI, it is not its main measure of inflation, which is the Commerce Department’s Personal Consumption Expenditures Price Index, which most recently came in at 2.5% for headline inflation in July.
Second, policymakers are almost as concerned about directional trends as they are about absolute values, and the trend over the past few months has been a clear moderation in inflation, particularly for headline prices, with the August 12-month CPI forecast showing a decline of 0.3 percentage points from July.
Finally, Fed officials’ focus has shifted from a keen eye on containing inflation to growing concerns about the state of the labor market: Hiring has slowed significantly since April, with the average monthly increase in nonfarm payrolls falling to 135,000 from 255,000 over the previous five months, and job openings also declining.
Small steps to get started
The increased focus on labor has also raised expectations that the Fed will start cutting interest rates. The benchmark federal funds rate is currently at 5.25% to 5.50%.
“The August CPI report should indicate further progress toward returning inflation to the Fed’s 2.0% target,” wrote Dean Baker, co-founder of the Center for Economic and Policy Research. “Barring any unusual surprises, there should be nothing in the report that would dissuade the Fed from cutting rates, perhaps by a large margin.”
But the market seems content with the Fed starting out slow.
Futures market prices on Tuesday suggested a 71% chance that the interest-rate-setting Federal Open Market Committee will kick off an easing campaign with a 0.25 percentage point cut, with just a 29% chance of a more aggressive half-point cut, according to CME Group’s FedWatch.
But some economists think that might be a mistake.
Citing a general decline in employment and a big downward revision in last month’s payroll numbers, Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, believes “the summer slowdown will likely intensify in the coming months” and that “the downward trend in employment is likely to continue for some time.”
“So while I am disappointed, I am not surprised that FOMC members who spoke after the employment report was released and before the pre-meeting blackout still leaned toward 25%. [basis point] “We expect to cut rates this month, but with two more jobs reports released before the November meeting, the case for a rapid rate cut will become overwhelming,” Toms said in a Monday note.
Indeed, market prices are expecting a gradual start to the rate cuts in September, followed by a half-point cut in November and a further cut in December.
