Fed’s Preferred Inflation Measure Comes In Hot

August’s inflation came in hotter than the U.S. Federal Reserve (Fed) would want to see in the August Personal Income and Outlays Report. Stripping out food and energy costs, prices rose at 0.6% month-0n-month rate using the Personal Consumption and Expenditure (PCE) price index. That translates to 7.4% annualized inflation, looking at the monthly trend in isolation, as compared to the Fed’s 2% goal.

Energy prices did fall broadly in August, so the PCE headline figures are a little better. Nonetheless, food costs rose 0.8% month-on-month. That’s a big concern for the Fed. In part, from the impact it has on lower-income households.

In addition, though the prices of goods fell, in part due to falling energy costs, prices for services rose 0.6% month-on-month. Overall, there was no real evidence that inflation is coming under control in this report. Inflation accelerated when compared with July.

Other Inflation Measures

This particular inflation measure is the one the Fed favors. This means it’s a clue to further interest rates hikes, when the Fed meets again in November and December 2022. Currently the market sees more rate hikes on the table at those meetings.

In contrast CPI inflation data, though still not reassuring, did offer some signs that parts of the economy are seeing prices moderate. That’s because CPI data is a little more granular in how it breaks down pricing, but also because the headline rate of CPI inflation came in lower at 0.1% compared to 0.3% in the PCE report.

PPI Data

Correspondingly, Producer Prices (PPI) fell 1.2% in August. That could be a leading indicator that prices are softening for consumers. That’s because prices for producers may lead those for end consumers. However, again, the Fed will want to see this in the numbers rather than speculate.

Still, PCE inflation gave one of the strongest inflation readings for the month of August when compared to other indices.

Services

One thing most inflation measures can agree on, is that prices for services continue to rise. That is exactly what the Fed does not want to see. It’s worried about inflation becoming entrenched in the U.S. economy. Prices for services are somewhat sticky, whereas prices for goods can be more volatile. As such, the continued price increases for services may be a signal that inflation could linger.

Forward-Looking Measures

Still, all these inflation reports are lagging indicators, as we enter October this data is providing insight on pricing trends from August. It’s relatively backward-looking.

Inflation Nowcast

The Cleveland Fed’s inflation nowcast for September currently has CPI inflation at 0.3% and PCE inflation at 0.3%. That’s a little better than some of the August data at least for PCE numbers, but, again, the Fed will want to look past headline numbers and swings in energy costs for signals as to how underlying inflation trends are looking.

Falling Prices?

Looking at more anecdotal current data there are some prices that are clearly in decline. Oil and gas prices have fallen in September in the U.S.. Freight rates for container shipping have fallen quite sharply for most of 2022. There are signs that U.S. house prices are starting to soften, and even food prices could moderate, if you examine recent trends in farm prices. Furthermore, as the risks of a U.S. recession appear to rise, that may cause certain prices to drop too, as businesses look to boost sales.

However, even these various trends, if they hold, may not prompt a broad enough or fast enough decline in prices to meet the Fed’s goals. It’s also clear that the Fed would much prefer to see more positive trends in these inflation reports. August’s data has offered them little to be optimistic about. That’s one reason why this September has been a rough month for financial markets.