Monetary Policy & Inflation | US
Inflation Shock Implies Major Fed Moves in July
- By Dominique Dwor-Frecaut
- 4 min read
Summary
- US inflation figures for June came out on Wednesday. The Consumer Price Index was again higher than expected at 9.1% and seems headed towards double digits.
- Goods price inflation is slowing, but services price inflation is accelerating.
- I now expect end-2022 inflation at 5.5%.
Market Implications
- Expectation-beating inflation will likely prompt the Fed to hike by 75bp at the July FOMC meeting.
- It will also probably raise the expected peak interest rate in its Summary of Economic Projections, eventually showing a terminal rate near 8%.
Inflation Keeps Climbing
US inflation stormed to a new 40-year high in June. Released Wednesday, the Consumer Price Index (CPI) rose 9.1% from a year earlier. This blew past expectations of 8.8% and raises pressure on the Fed to hike rates more aggressively at the next FOMC meeting later this month.
The month over month figures were also alarming. Headline came in at 1.3% and core at 0.7%. This was against 1.1% and 0.5% expected and 1% and 0.6% in May.
Perhaps more important, though, was the six-month annualized figure: core inflation accelerated to 6.8% from 6.5% in May. Because of the unusual volatility in inflation, this measure is proving a more reliable indicator of trends – and it is creeping up (Chart 1).
Two other indicators have also become more reliable than core inflation: the trimmed mean and median price CPI. These ignore the largest price changes and so a less noisy than the core figure, which has grown volatile due to large and repeated supply shocks. Both trimmed mean and median price CPI confirm the acceleration in inflation (Chart 2).
I Expect Inflation at 5.5% by End-2022
As I expected, core goods price inflation slowed, and core services inflation accelerated. Core goods price inflation remains on track with my forecast of a slowdown to about 4% YoY by end 2022. So far, it has fallen from 12.4% YoY in February to 7.1% in June.
Core services inflation, by contrast, accelerated further in June to 5.5% YoY from 5.2% YoY in May. Historically, services inflation and wage growth are strongly correlated, and the ongoing acceleration in services inflation suggests wage growth must be accelerating too (Chart 3).
I now expect services inflation to reach 6% by end-2022. That brings my overall core inflation scenario to 5.5% from previously 4.75%.
Market Consequences
Early reactions from FOMC members to today’s data suggested a 100bp hike is possible at the July meeting. Both Atlanta Fed President Raphael Bostic and Cleveland Fed President Loretta Mester have refused to rule it out. Bostic, for example, said ‘everything is in play’ come the next meeting.
Against a backdrop of inflation nearing double digits, the Fed would struggle not to follow through without losing further credibility. However, more recent comments seem to imply a 75bp is more likely.
The bottom line remains that the Fed is likely to hike by more than the market expects. The rate cuts priced by the market starting in January 2023 appear unlikely. To the contrary, worse-than-expected inflation dynamics are likely to see the Fed lift its interest rate trajectory and eventually, possibly in 2023, publish a Summary of Economic Projections (SEP) showing an expected peak in interest rates of 8% – together with a much higher peak unemployment rate than the 4.1% shown in the June SEP.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)