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Inflation at 40-year highs, we hardly knew you.
In the five months through November, the Consumer Price Index (CPI) has increased at an annualized rate of 2.5%, only a little above the Federal Reserve’s 2% long-term inflation target.
The rapid slowing from an annualized rate of more than 10% in the seven months through June is the result of lower energy and grain prices and the declines in the cost of other key commodities like plastics and lumber, as well as shipping.
Key Takeaways
- Inflation has been fading, with U.S. consumer prices up an annualized 2.5% since June.
- The prices of key commodities including energy, plastic, and lumber have slumped, and shipping costs have also tumbled.
- The December jobs report showed wage gains moderating, with average hourly earnings up 0.3% and weekly earnings down.
- Federal Reserve officials have downplayed the good news, preparing markets for further rate hikes.
- Bonds rallied this week amid optimism the Fed has headed off stagflation.
Federal Reserve officials have downplayed these developments, opting to focus on the continued inflationary threat and their determination to stamp it out. After raising the Fed’s benchmark rate from near zero to nearly 4.5% in the course of 2022 and preparing markets for more hikes, they likely view hawkish talk as a low-cost restraint on inflation expectations.
Consumers also remain unconvinced, with 65% in a recent Gallup poll predicting high rather than “reasonable” inflation in 2023. People with lower incomes especially continue to struggle with the cumulative toll of recent price hikes on necessities. With prices at the pump down sharply, inflation spotters have moved on to gripe about those of a Manhattan cup of coffee and wholesale eggs.
Financial markets, on the other hand, are treating the price surge in the first half of last year as old news while giving more credence to the encouraging recent data. Breakeven spreads reflecting the market’s expectations for inflation have shrunk for months, and narrowed further Friday after December’s strong jobs report showed wage gains moderating. Treasury bonds, beat up in 2022 as inflation spiked, perked up this week. The 10-year Treasury note’s yield dropped from 3.88% to 3.57% over the new year’s first four trading sessions. The S&P 500 index rallied 2.3% Friday.
Investors welcomed the news that U.S. workers’ average hourly earnings rose 0.3% in December, below expectations for an increase of 0.4%. Just as importantly, the Bureau of Labor Statistics (BLS) revised November’s average hourly earnings gain to 0.4% from the 0.6% reported previously. Between the lower December number and the November revision, the year-over-year (YOY) gain in average hourly earnings fell from 5.1% before the report to 4.6% after. Average weekly earnings declined for a third straight month as a result of a shorter average work week.
Federal Reserve Chair Jerome Powell has said he is particularly focused on inflation in core services prices excluding housing in explaining the central bank’s continuing hawkish tilt. “This may be the most important category for understanding the future evolution of core inflation. Because wages make up the largest cost in delivering these services, the labor market holds the key to understanding inflation in this category,” Powell said in a Nov. 30 speech.
November inflation data released two weeks later showed the price of services excluding housing and energy rose just 0.1%, slowing from gains of 0.4% in October and 0.8% in September in another sign of easing price pressures. Federal Reserve officials have worried higher prices could spur wage demands, triggering a wage-price spiral. While that phenomenon contributed to the stagflation of the 1970s, today’s lower labor union participation rate and the diminished collective bargaining power of workers make a repeat less likely.
The recent inflation slowdown could prove short-lived, of course. The job market’s strength will keep the pressure on employers to bid wages up to reduce a historic backlog of vacancies. China’s reopening after three years of COVID-19 lockdowns may boost long-term demand for energy and other commodities, lifting prices.
U.S. inflation hasn’t “turned the corner yet,” said Gita Gopinath, the No. 2 official at the International Monetary Fund (IMF), in an interview published Friday, citing the strong job market as a risk.
Still, until the data or the news provide evidence of a trend change, the stock and bond markets may keep discounting inflation’s staying power.
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