Because of the government shutdown, the October consumer price index will not be available for the second straight month.
It will be another month before policymakers, investors and the public get a good look at the direction of inflation, which through September was up 3% from one year ago and was up 3.6% on a three-month annualized pace.
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In our estimation, the best look at inflation during the long shutdown was the New York Fed’s year-ahead inflation expectations, which imply that pricing will increase 3.24% in the year ahead in contrast with the University of Michigan’s year-ahead estimate of 4.7%.
Our preferred market-based metric—the five-year, five-year forward breakeven—implies a 2.34% pace of inflation over a longer period.
But no matter how one slices the data, inflation is likely to rise faster than the Federal Reserve’s 2% target with risk of moving higher as the strong fiscal impulse that will hit the economy next year bolsters growth prospects.
Our models of the Federal Reserve’s reaction function—we run four separate models to estimate the optimal policy rate—all imply that it would be prudent for the central bank to remain on hold at its December meeting because of the fog of uncertainty around U.S. macroeconomic data.
The central bank can resume reducing its policy rate next year once it gets a full accounting of the economy following the self-inflicted harm of the shutdown that will shave roughly 1.5% from GDP in the current quarter.
We are entering an interesting period where the economic populism that is in fashion gives birth to ideas such as $2,000 tariff rebates—that is purely inflationary—to mitigate the affordability crunch that is hurting middle- and lower-income households, which make up the lower spur of the K-shaped economy.
Given the current economic and policy context, it is prudent for the Fed to take the necessary time to observe how the economy responds to the expansionary fiscal policies that will kick in next year.
At the end of the day, it is those who live and work in the lower spur of the K who will bear the burden of adjustment to higher inflation through a lower standard of living, diminished opportunities and stagnant wages that will not adjust upward because of tariff-induced policy changes such as rebates.
