CPI Figures Encouraging, But Fed Remains Likely To Hike

The consumer price index increased at a 0.2% monthly rate for June. The increase was the same for both the headline rate, and for core inflation, which excludes food and energy. That’s the smallest monthly increase since August 2021, and headline inflation rose at 3%. However, the Federal Reserve is still likely to argue that core inflation rising at a 4.8% annual rate is well above their 2% inflation goal and raise interest rates later this month as a result.

Shelter Costs Coming Down

Perhaps the most encouraging aspect of the June CPI report was that shelter costs rose at a lower rate than in many prior months. The increase for June was a monthly rate of 0.4% for the shelter component. That’s still high, but shows that shelter costs in CPI may be starting to mirror the cooling home prices that we’ve seen in industry data. The lag is not unexpected because the CPI uses a panel approach to measure housing costs that introduces a lag to current pricing, of 6 months or so.

Still shelter costs will likely need to come down further for the Fed to be satisfied as the annual increase is still running at 7.8%, and even this month’s 0.4% increase translates to almost a 5% annual increase. Shelter costs matter because they carry a high weight in the CPI series, if they continue to ease, then the resulting disinflation should help CPI trend down overall.

Services Costs

The Fed remains concerned about services costs. Wages are currently rising at relatively fast levels, albeit with some recent signs of cooling. The Fed is concerned that services costs will remain stubbornly high and prevent inflation falling back to their 2% goal. Today’s report was fairly encouraging as certain services did see monthly price declines including certain medical, recreation and pet services. However, other services including hospital care, transportation, haircuts and legal and financial services rose in price for the month. On balance, this is likely an aggregate improvement over prior months for services price trends, though the Fed may want more data from future CPI reports and their preferred PCE inflation metric later this month to confirm the trend.

The Fed’s Reaction

With two weeks until the Fed’s next rate decision, markets believe that a 0.25-percentage-point increase in interest rates is virtually a lock. Specifically, the CME FedWatch Tool using interest rate futures puts the chance of a hike at over 90% currently and the Fed has made various hawkish statements to the effect that July interest rate hike is likely including economic projections from the last meeting implying further 2023 interest rate hikes.

However, today’s data is broadly encouraging. The Fed has been clear that it wants to see inflation very clearly move back to 2% before it considers easing back on interest rates. Today’s CPI data did not provide that clarity, but did show come encouraging early signs especially for core inflation, that will please the Fed if they continue.