Is Inflation Finally Cooling Down?

Key takeaways

• August’s Consumer Price Index (CPI) data was released early Tuesday morning, finding that headline inflation has increased 0.1% in August and core inflation has climbed 0.6%.
• With these latest results it’s no surprise that some Federal Reserve presidents maintain that interest rates could climb above 4% and remain there until next summer
• Prior to Tuesday’s release, economists pointed to various signals, like falling rent prices, to suggest that inflation is cooling down
• Experts forecast the Fed hiking interest rates 0.5% to 0.75% in their September meeting, stoking recession fears among investors and consumers

Last month, officials released data showing that the Consumer Price Index fell further than expected in July, triggering a short-lived relief rally in the stock market. In the last week, an anxious market saw stocks tentatively rise as a weaker dollar and the specter of lower prices carried the rally onward. On Friday, all three major averages rebounded to snap a three-week losing streak.

Experts and investors see August’s inflation data as key to determining whether (or how high) the Federal Reserve will hike interest rates in its September 20-21 meeting. Approaching Tuesday’s release, economists predicted a hike ranging from 0.5% all the way up to 1%.

Now, the data is in – and it’s not great news for investors. With prices rising 0.1% in August, the headline annual rate over the past 12 months has hit 8.3%. That’s down from last month, but is higher than analysts expectations which projected a drop of 0.1%.

Expectations going in: Is inflation cooling down?

The Consumer Price Index (CPI) is an essential inflation metric for determining the overall trajectory of the U.S. economy. (Inflation is a gradual rise in prices, or the decline of a dollar’s purchasing power, over time.)

The Fed tends to focus on two parts: the headline number, which looks at inflation across the board, and the core number, which strips out food and gas prices. (Both food and gas are metrics known for high volatility.)

Ahead of Tuesday’s inflation report, experts speculated that August’s inflation data would play into the Fed’s September rate hike decision. It’s not just the headline numbers that matter – the data inside gives a sneak peek into how different sectors of the economy fare against inflationary headwinds.

Wall Street broadly expected that headline CPI would decline about 0.1% month-over-month in August. That would bring inflation down between 8%-8.1%, compared to July’s 8.5%. Core CPI projections sat a little higher, with gains of 0.3% after stripping out energy’s recent declines. All told, economists broadly predicted core CPI to land at 6% year-over-year.

Nobel Prize-winning economist Paul Krugman tweeted Sunday that he based inflation expectations on sluggish rent prices. Particularly, he noted, “Rents – market rents and imputed rents on owner-occupied housing – are key drivers of all measures of core inflation.”

On a broader scale, many have cited falling gas prices as the biggest driver of inflation declines. Between mid-June and Monday, gas marched down from $5.01 to just $3.71 per gallon of unleaded.

So, is inflation cooling down? The latest CPI data

The Consumer Price Index was released this morning at 8:30 a.m. ET. It showed that prices have risen 8.3% over the past 12 months to the end of August.

The story was even worse for core inflation, which removes volatile products such as food and energy. It rose by 0.6% to take the annual rate to 6.3%.

There was a big fall in energy commodities like gasoline and other fuel oil, but a rapid increase in energy services like electricity and piped gas.

Also driving the increase was a significant rise in prices for food, medical care, shelter and new vehicles.

Overall, prices are rising slower than they have been, but they’re still rising.

Officials posit concerns ahead of Tuesday’s inflation report

Already this year, the central bank has spiked interest rates to a range of 2.25%-2.5% in its fight against inflation. Officials had already indicated that they were willing to lift interest rates an additional 0.75% in September prior to Tuesday’s inflation report to constrain economic growth and lower prices.

But the Fed may not stop there.

Esther George, president of the Federal Reserve Bank of Kansas City, suggested during a recent interview with Bloomberg Television that interest rates may climb above 4% and stay there for several months.

Her statement runs contrary to investor expectations that the Fed will approach – but not exceed – 4% by next summer before lowing rates again.

George’s comments put numbers to the Fed’s intention to corral inflation fully, rather than pulling back at the first sign of lower prices.

On Friday, Loretta Mester, president of the Federal Reserve Bank of Cleveland, echoed her agreement.

Mester warned that she doesn’t “have enough evidence now to even conclude that inflation has peaked in the U.S.” She further cautioned that she’s “still very concerned about inflation,” as it remains at “unacceptably high levels.”

Moreover, she believes that “the Fed is going to have to do much more to get that inflation data on that downward path…. My read right now is we’ll probably have to bring the nominal Fed funds rate up a bit above 4% by early next year, and then keep it there throughout the year.”

Interest rate anxiety spurs recession fears

It’s exactly this line of thinking from the Fed that continues to spur recession fears in consumers and investors – a fact that Mester acknowledges.

She added that the Fed will hopefully hike rates “in a way that the economy won’t go into a deep recession.” At the same time, she admitted that the process will “be somewhat painful, and it’ll feel painful.”

Still, she – alongside George – believe that this temporary pain will relieve long-term inflationary pressures.

What Tuesday’s inflation report means for interest rate, recession fears

Tuesday’s inflation report plays into these beliefs, and simultaneously, into recession fears. Given how stubbornly high prices remain, Tuesday’s numbers may not be are unlikely to ease Fed concerns, if George and Mester’s statements are any indication.

As such, that still leaves the question of how high the Fed will hike its short-term rate in September. Though the federal funds rate only directly impacts the interest rate banks charge each other on overnight loan, the effects trickle into a variety of business and consumer debts, like auto loans, mortgages, credit cards and business loans.

In turn, higher rates slow the economic gears and can even trigger recessions – or at least, recession fears – if spiked too high, too fast.

Prior to Tuesday’s release, Wall Street estimated that the central bank would hike rates between 0.5% and 0.75% based on inflation data. Now that the numbers are in, an even higher figure could be a possibility.

Inflation cooling down may not be enough

However, there’s no guarantee that August’s inflation data will matter at all. Only time will tell what, if any, metrics the Fed calculates into this month’s rate change.

For instance, some economists predict that food, rent and gas prices could factor heavily into the Fed’s decision.

Others suggest that, regardless of CPI, recent labor market and unemployment data provide sufficient cause for the Fed to remain aggressive at least through September.

Ironically, economists also note that lower inflation in some areas could extend economy-wide inflation.

Particularly, as falling gas prices leave more money in consumer wallets, they may increase spending elsewhere. That could encourage higher prices elsewhere in the economy, buoying inflation as the economy and labor market continue to expand.

(Though with OPEC’s recent announcement to support prices by slashing production, today’s lower gas prices aren’t guaranteed, either.)

What does this mean for investors?

Stock market volatility kicked in last week as investors prepared for Tuesday’s inflation report and September’s Fed meeting. While anxiety and recession fears played their part, prices (and sentiment) were supported by a weaker U.S. dollar and good news from Ukraine’s military.

As of Monday, investors appeared more optimistic than not. All three major indexes closed their fourth session of gains in a row, while Treasury yields remained mixed.

Still, the mixture of rate hikes and inflation continue to impact investor prospects.

Usually, rate hikes mute investment gains as businesses find borrowing and expanding more expensive. On the other end, sky-high inflation also tamps down investment values as consumers spend less and business expenses rise.

That leaves investors in a tight spot, with two separate-but-related forces pressing down gains at the same time. Though investors tend to view rate hikes negatively (as they did back in spring), recent hikes have been better received as record-high inflation and recession fears dash corporate profits.

As a result, some of this year’s massive stock market declines evened out over the summer, with some finally returning to black. Others, especially historically volatile assets like tech stocks and crypto, remain well in bear market territory.

This recent optimism dissipated quickly on Tuesday morning, with the poor inflation result and the prospect of a further rate hike sending markets spiraling. The S&P 500 continued to slide throughout the morning and as of the time of writing is down 2.75%.

Whether inflation cools down or not, Q.ai has your back

Ultimately, it’s unlikely that August’s CPI data will hugely influence the Fed’s decision to hike interest rates. After all, it’s not an if, but a how much. In the same vein, the Fed’s response to CPI data likely won’t be enough to single-handedly spike investor fortunes or dampen market volatility in these uncertain times.

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