Demand for discretionary services, a steady advance in tariff-induced inflation and rising gasoline prices all contributed to a 0.4% (0.382%) monthly increase in the consumer price index for August and a 2.9% annual increase.
Core prices, which exclude the more volatile food and energy components, rose by 0.3% (0.346%) on the month and by 3.1% on the year.
Clear trends in the CPI data strongly point to the fact that tariffs are pushing up consumer prices.
Perhaps more important, demand for discretionary services remains stubbornly strong despite a slower pace of hiring and a softer pace of wage growth, which one can observe in the easing of real average hourly earnings to a 0.7% increase on a year-ago basis, down from 1.2% previously.
The result of these rising prices and easing hourly earnings is the emergence of stagflation in the American economy.
While we expect the Fed to cut its policy rate on Sept. 17, it is rare that a rate-cutting cycle starts with fundamentally solid discretionary demand driving service sector inflation higher.
While the labor market is far softer than previously thought, it does not appear that the real economy is slipping into a recession.
From my point of view, this strongly implies that the Fed should proceed cautiously in signaling three consecutive rate cuts this year, especially given the near-term arrival of expansionary fiscal policies featuring tax cuts and retroactive full business expensing.
The formal models that I run to estimate the optimal policy rate that use both the CPI and core CPI imply policy rates of 4.6% in the former and 4.9% in the latter. Those figures are not aligned with the direction of Fed policy. Indeed, If I were voting on the Federal Open Market Committee, I would strongly consider a formal dissent.
The data
August inflation arrived hot because of a 5.9% monthly surge in airfare prices, a 1.9% increase in gasoline prices, a 0.9% rise in transportation costs and a 0.5% advance in food and apparel prices in the month.
Food-at-home prices increased by 0.6% in the month and were up by 2.7% from a year ago.
The large price increase of 2.7% for beef and veal, which translated to a 13.9% rise from a year ago, certainly added to sour public sentiment on inflation.
Fresh vegetables increased by 3% on the month while the price of tomatoes climbed by 4.5% in August, which are directly attributable to import taxes.
Energy advanced by 0.7% on the back of a 1.7% rise in energy commodities and the strong advance in gasoline prices.
Service prices rose by 0.3% as were services ex-energy while housing, shelter and the policy sensitive owners’ equivalent rent series all advanced by 0.4% on the month.
That large jump in monthly transportation costs was driven by a 1% increase in used cars and trucks and a 0.3% increase in new vehicles.
Medical costs dropped by 0.2% while recreation prices dropped by 0.1%, and education and communication prices were flat.
The takeaway
Stagflation continues to be the primary narrative underscoring the American economy. It has been four decades since Americans experienced stagflation. One gets the sense that rising food and energy costs, which directly affect consumers as they make economic decisions, are moving in the wrong direction.
A steady, and stubborn increase in service sector prices was the major driver of the 0.4% upside surprise in the consumer price index. In addition, one can observe a large increase in imported food costs, goods prices as well as motor vehicle and parts costs that are a function of tariffs.
Demand for discretionary services and upward price adjustments to meet that demand strongly suggest an economy that is not near falling into recession. As such, Fed rate cuts are likely to be live options at each of the three meetings remaining this year with a cut at the September meeting all but certain while rate cuts at the October and December meetings are yet to be determined.
