Disappointing Nowcasts For Upcoming Inflation Highlight Fed’s Concerns

U.S. Federal Reserve Chair Jerome Powell indicated that rate hikes may be ending in early 2023, but he still worries about inflation. Though we’ve seen encouraging inflation data for the month of October, nowcasts imply that inflation may not come down much in November or December numbers. If this trend persists, it could mean the Fed leaves rates high for much of 2023.

Nowcasting Concerns For Inflation

The Atlanta Federal Reserve creates nowcasts for inflation data. Looking at current prices they can estimate what the numbers will be in the final government reports. It’s historically been reasonably accurate.

Certainly, inflation data is looking better than it was, but for both November and December inflation is expected to rise 0.4% to 0.5% month-on-month for both CPI and PCE inflation metrics. If sustained, that then translates to annual inflation in the 5% to 6% range.

Stubbornly Sideways

This supports the concern the Fed has. Yes, inflation may have peaked. Still, it’s not falling much either. Inflation of 5% to 6% is still way above the Fed’s 2% target. At a recent Brookings Institution speech, Jerome Powell used the term “stubbornly sideways” to describe how inflation has moved for much of 2022. Inflation has come down slightly, but not dramatically.

Better News In 2023?

Still, 2023 may hold better news for inflation. It is understood that the method of housing cost calculation in the CPI has a lag of several months to current house prices, given the CPI inflation methodology. This means that housing costs may decline in the CPI index in 2023. That could be enough to bring inflation down further, since housing carries a large weight in the CPI calculation.

Also, certain goods, such as used cars, appear to be moving to absolute price declines, that too could bring inflation down even if some prices are still moving up. Still the Fed worries about wage inflation, and that is running at over 6% on the Atlanta Fed’s estimates. That could continue to push up prices for services.

The Fed signalling interest rate hikes may be coming to an end has been greeted positively by the market. However, the Fed’s other message, that rates may have to remain high for some time until inflation moves lower, is something the market may have yet to fully internalize.

Nonetheless, perhaps the inflation numbers in 2023 will be better than the Fed expects, or maybe a recession will force lower rates regardless. Either way, the final inflation reports of 2022 may not be all that encouraging.