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What We Got Right: Solid Inflation Calls And An End To The Q1 Inflation Debate

While we weren’t as on target on the July Inflation Core-Cast as we were on the May and June readings, we still had a solid month - just two (2) basis points off the final readings for both m/m and y/y Core PCE and nailing the nowcast for Q2 monthly revisions. The July inflation reading ends the debate regarding hotter-than-expected Q1 inflation readings. As we noted in real-time, the story of the hot inflation during Q1 was due to residual seasonality and other idiosyncratic factors (e.g. financial services “inflation”) rather than a reacceleration or “last-mile stubbornness.”  

Two Curveballs This Month: Another Outlier Reading In Rent CPI And A Mixed Bag In Industrial Production

Rent inflation came in hotter than anticipated in July after disinflationary readings on housing in the June print. Similar to what we saw in the May print, this was due to local idiosyncrasies, and we fully expect rent to add downside risk to inflation readings going forward. 

As noted by EA Senior Economist Alex Williams in the July Industrial Production edition of the Supply Chain Monitor, the headline number for July IP suggested a sharp slowdown, but this was primarily driven by a big drop in motor vehicle production. Electronics production is still accelerating and we saw a recovery in electrical equipment production - especially welcoming given the continuing shortages. Construction materials supply continued declining from its peak due to high interest rates hampering new home construction. With that being said…

What We’re Looking Forward To: The Interest Rate Normalization Cycle Is Finally Here

The moment we’ve all been waiting for - at the Jackson Hole Economic Policy Symposium, Chair Powell forcefully declared, “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.” Most notably, he stated that he did not seek or welcome further cooling in the labor market, and he did not prematurely commit to a gradual pace of rate cuts. Unfortunately…

What We’re Concerned About: FOMC Members Boxing Themselves Into A Policy Error Due To Poor Communications 

The FOMC is on the verge of boxing itself into some serious policy errors. EA Senior Economist Preston Mui noted last week, certain FOMC members have tried to lock themselves into a gradual path of interest rate cuts. 

The balance of risks has clearly shifted toward labor market deterioration as opposed to a reacceleration of inflation, and there is too much uncertainty around the labor market to be locked into any decision regarding the size and path of interest rate cuts. Poor communications have already locked the Fed into mistakes in the past, most recently by prematurely taking July off of the table. If they continue to do so, the FOMC risks making a policy error and being late to normalizing policy.

It’s not too late for the FOMC to course-correct. In the last week of Fed communications before the blackout period for the September FOMC meeting, every member should preserve the option for the size and timing of interest rate cuts. This is especially true given that another round of both jobs and inflation data will be released prior to the meeting. If anything, the Fed should be even more open to front-loading the interest rate normalization cycle purely from a risk management lens, as EA Executive Director Skanda Amarnath and Senior Economist Preston Mui noted in December 2023. 

Our base case is currently a 50 basis point interest rate reduction at the September FOMC meeting, but this view is admittedly on a knife’s edge. The August Jobs report on Friday will give us a clearer picture, and we will outline various scenarios in the lead-up to Friday’s report.