This week’s consumer inflation news confirms that the Federal Reserve’s interest rate hikes are nearing an end. The basic calculation is that if disinflation persists, the chances increase that the central bank will suspend its monetary tightening policy.
Consumer prices in the United States rose in June at the slowest pace since March 2021, further confirming that the Fed would put rate hikes on ice. The descent in underlying inflation is still relatively persistent, which leaves more room for caution when looking at overall comparisons, which are weaker mainly due to lower food prices and the ‘energy. But examining a wide range of inflation measures indicates that disinflation is robust. (For a listing of the inflation indices in the chart below, see page 3 of CapitalSpectator.com’s The US Inflation Trend Chartbook, which is mailed monthly to subscribers of The U.S. Business Cycle Risk Report.)
The bias (month-to-month change in the 1-year trend) has become more pronounced lately for the average 1-year change in the chart above. This is a hint to expect the recent run of disinflation to remain robust in the near term.
Meanwhile, the Fed’s monetary policy remains moderately tight, based on a simple model that compares the Fed funds target rate to unemployment and inflation. As inflation slows to a healthy pace, the central bank can be confident that it can put rate hikes on hold and allow the currently moderately restrictive policy stance to exert downward pressure on prices.
The policy-sensitive 2-year Treasury yield, which is trading below the target federal funds rate, continues to price in expectations that the target federal funds rate is near a high, if not higher. has not already peaked.
Fed funds futures call for high odds for another rate hike at the July 26 policy meeting, followed by moderately high odds for a break at the two subsequent FOMC meetings.
Although the case for a pause in rate hikes is growing stronger, a Fed official warned yesterday that it is premature to declare victory on inflation and assume that rate hikes are over. Mary Daly, President of the San Francisco Fed advise that while “there is no doubt that good news on inflation is good news, it is really too early to declare victory on inflation”.
It’s clear: the latest inflation numbers raise the odds that the Fed’s rate hike cycle is about to peak. Positive surprises from incoming inflation figures could derail optimism, but for now the crowd is reading the tea leaves and growing more confident that the end game is in sight.
Commenting on the June inflation report, Goldman Sachs economists writing Wednesday: “Today’s report is consistent with our view that Fed tightening is in its final round.”
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