Some signs that U.S. price pressures are easing even as overall inflation stays high could persuade Federal Reserve policymakers to go for smaller interest rate hikes after they implement a fourth consecutive supersized rise next week.
While the Commerce Department posted on Friday that underlying inflation pressures remained relentlessly high in September, the Labor Department’s Employment Cost Index hinted at a considerable slowdown in private-sector wage growth in the third quarter – it jumped 1.2% from 1.6% in the second quarter – indicating the possibility of a scenario of ever-growing wages driving prices higher may be receding.
Fed policymakers are paying close attention to the ECI as a predictor of core inflation and one of the better measures of labor market slack. Andrew Hunter, senior U.S. economist at Capital Economics, said:
“Although another 75bp (basis point) rate hike lies in store next week, we suspect that slowdown (in wage growth) will help convince the Fed to slow the pace of tightening in December.”
With the U.S. central bank almost confident to raise its benchmark overnight interest rate by 75 basis points to the 3.75%-4.00% range at its Nov. 1-2 policy meeting, investors are currently concentrating on what’s coming in December and early 2023.
Projections issued in September showed policymakers’ median forecast for the federal funds rate by the end of 2023 at 4.6%. Fed officials have said they anticipate reaching that level by early 2021 and several then want to stop, contending that the economy will need time to soak up the fastest pace of tightening in four decades and that an easing in inflation is likely to lag the rate rises.
Several policymakers in the past month have also seemed to be advocating for a smaller rate increase at the Dec. 13-14 meeting.
Futures contracts linked to the Fed’s benchmark overnight interest rate slightly changed after release of Friday’s data, still pricing in a half-percentage-point increase in November and another 50 basis points over the first two meetings of 2023.
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Whether the Fed can stay on its preferred path of a pause around 4.6% remains to be seen. Certainly, the most recent Personal Consumption Expenditures (PCE) price index data did little to boost central bank hopes that price pressures have stubbornly turned a corner.
The PCE price index, which is the Fed’s preferred metric as it monitors progress in cooling inflation to its 2% target, jumped 0.3% on a month-to-month basis and 6.2% on a year-to-year basis last month, matching the gain in August.
Excluding the volatile food and energy components, the PCE price index rose 0.5% last month, matching the advances in the previous month, and 5.1% in the 12 months through September, against a 4.9% year-on-year jump in August.
That was enough for one analyst to contend the market is undershooting the amount of Fed tightening that remains.
Oliver Pursche, senior vice president at Wealthspire Advisors, said:
“Inflation is still running way too hot, the month-on-month numbers are holding steady … the numbers also show that the Fed is going to have to continue to raise rates and tighten probably longer than the market is pricing in currently.”
