If the August Consumer Price Index and Producer Price Index arrive anywhere near the consensus forecast this week, investors and firm managers should prepare for not only one rate hike by the Federal Reserve but also a series of increases that would reverse the accommodation put forward late last year.
Economists expect a 0.4% monthly increase in both top-line PPI and CPI with the core rate for the former increasing by 0.3% and 0.2% for the latter.
On a year-ago basis, top-line PPI, which will be released on Thursday, is expected to advance by 5.2% and 4.6% in the core. CPI, which will be released on Friday, is forecast to increase by 3.4% from one year ago for headline inflation and by 2.5% in the core.
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We agree with the consensus and think that the risk is that CPI will arrive at a 0.5% pace in August. When rising oil prices are factored in, all signs point toward a rate hike at the Federal Reserve’s policy meeting on Sept. 16.
Once the Fed and economists get the CPI and PPI data, it will be quite easy to estimate the top-line and core personal consumption expenditures index that the Fed uses to make policy.
That is why once the PPI is published, economists will quickly look at seven different subindices that feed into the estimate of PCE—domestic air prices, portfolio management, physician care, home health and hospice care, hospital outpatient care, hospital inpatient care and nursing home care.
But one needs to look only at oil prices, which advanced by 1.3% in August and have increased by more than 23% from one year ago, to get a sense of why policymakers at the Federal Reserve are growing impatient with inflation staying above the Fed’s 2% target for more than five years.
What were thought to be temporary factors keeping inflation high now look to be persistent. The war-induced energy shock is now in its seventh month with no end in sight as crude prices float above $90 per barrel.
The impact of tariffs on inflation, thought to be more of a one-time pass-through, is proving to be more enduring as the U.S. administration continues to use tariffs as a cudgel to obtain its political objectives in an ad-hoc fashion.
In addition, the build-out of artificial intelligence data centers is drawing on commodities and final goods in such a way that is also driving inflation higher.
For the Fed not to increase rates, we think we will need to observe a top-line monthly increase of 0.25% or less.
We have been quite public about the fact that we thought the economy was too strong and at full employment when the Fed cut rates late last year and equally clear that the Fed should have hiked rates in July.
The Fed has three tools to move inflation back to 2% since prices are clearly not going to move back on their own: the balance sheet, communications and the federal funds rate.
Balance sheet contraction is not in the cards and communications policy is confused, so that means it is the federal funds rate that will have to change should the Federal Open Market Committee intend to move inflation back to target.
At this point, the Fed has effectively talked itself into a corner and needs to be bailed out by the data this week to push back the inevitable.
