Encouraging CPI Inflation Report May Signal An Earlier Fed Pause

The November Consumer Price Index (CPI) Report for the month of October offered signs that U.S. inflation may be coming down. Prices increased 0.4% month-on-month, and prices less food and energy rose 0.3%. These were low enough to cause the year-over-year inflation rate rate to fall to 7.7%.

This is just one month of price data, but contained a lot of hints that suggest U.S. inflation may be declining, as more prices are dropping on a monthly basis in absolute terms. Still, we have some way to go before inflation hits the Fed’s 2% goal.

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Some Prices Are Falling

A broader set of prices are now falling, these include used cars, clothing and medical services. Certain energy-related costs fell too, though those series are more volatile. At a more granular level, certain home furnishings and appliances fell in price as well as various food items (discussed below). These falling prices can help offset those prices that are still rising and help bring inflation down. Previously most prices were rising in unison.

Housing And Food Prices

Housing and food carry a large weight in the CPI index. Housing costs continue to rise. In fact, the pace of increase accelerated in the November report as was the largest monthly rise since November 1990.

That is at odds with the softness we’re seeing in the U.S. housing market. The reason for this is the statistical details of how the CPI series is calculated, making it more of a lagging indicator of house prices over recent months.

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However, the Fed understands this and may be less concerned about the rise in housing costs, given the trend is expected to turn at some point in the coming months. If and when it does that may help push inflation lower.

Food

Food prices may be starting to ease. This is welcome news as rising food prices hit those on lower incomes disproportionately. Food costs are also a large part of the CPI calculation. Food prices have risen at an almost 11% annual rate over the past 12 months. However, in the November report the increase was 0.6% month-on-month, implying a 7.4% annualized increase.

Food prices are still rising sharply in aggregate, but perhaps these increases are slowing. Animal protein, eggs, cereal and beverage costs are still generally rising. However, in a welcome change, fresh fruits and vegetables as well as milk are now falling in price.

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So the general picture is that inflation is still very high and well above the Fed’s target. However, if the trends in today’s report hold we are starting to see more and more prices declining in absolute terms, offsetting those that are still rising in price.

Also, a large portion of rising prices is due to housing costs given their large weight in the CPI. Here we can be somewhat confident that current softness in housing should ultimately translate to the CPI series at some point in the coming months.

Fed’s Reaction

We are not out of the woods yet, but this was the sort of data the Fed was hoping for, especially when nowcast forecasts had suggested inflation may come in at a higher level.

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Of course, a single month of data does not make a trend, and we’ve seen low monthly readings before that didn’t last, such as in April of this year. However, there is evidence that inflation is easing. Now the challenge is where inflation it goes from here. Even the November report implies 5% annualized inflation, which is well ahead of the Fed’s target. The Fed had already indicated it was looking to pause rate hikes at some point in the first half of 2023, with the November CPI report the timing for that may have been pulled forward. This may also set up a smaller hike at the Fed’s December meeting if subsequent economic data is supportive.