Inflation and emergencies
This was inflation data week. The Producer Price Index (PPI) was released on Tuesday and the Consumer Price Index (CPI) was released on Wednesday.
The headline CPI number came in at 2.9% and ‘core’ came in at 3.2%. I’ve included in the chart the Owner’s Equivalent Rent which has come down substantially but is continuing to hold up further progress.
Using my favorite inflation tracker, the Case-Shiller Home Price Index, we can see that Owner’s Equivalent Rent lags the actual dynamics of the housing market.
It’s important to note that the Case-Shiller Index is updated with a big delay. The most recent data is from October. We’ll get another update on this index January 28th.
Fed Governor Chris Waller spoke towards softer inflation data last week in France.
“Let me explain why I expect inflation to continue toward our goal. First, as we saw a year ago when inflation briefly increased, progress has been uneven, but disinflation is more apparent if one smooths through the recent upticks. To tease out the underlying trend in inflation, I often look at the six-month percent change in core PCE prices, which is 2.4 percent at an annual rate for November and has mostly been moving down toward 2 percent over the course of the year. Second, the monthly reading for November came in much lower than expected at 0.11 percent after rising 0.26 percent in October. Third, inflation in 2024 has largely been driven by increases in imputed prices, such as housing services and nonmarket services, which are estimated rather than directly observed and I consider a less reliable guide to the balance of supply and demand across all goods and services in the economy. These two categories represent about one-third of the core PCE basket. If you look at the prices associated with the other two-thirds of core PCE, they on average increased less than 2 percent over the past 12 months through November. I don't support ignoring our best measures of prices for housing and non-market services, but I find it notable that imputed prices, rather than observed prices, were driving inflation in 2024 and thus expectations of the policy rate path. Finally, the higher inflation readings from early in 2024 will begin to drop out of inflation numbers in January. This should result in a significant step-down in the 12-month inflation numbers through March.”
With this in mind, I believe that the market is under anticipating the amount of rate cuts that will happen in 2025.
Current probabilities point towards only one cut in 2025. Governor Waller is on-board with cutting. During his remarks he said, “So what is my view? If the outlook evolves as I have described here, I will support continuing to cut our policy rate in 2025. The pace of those cuts will depend on how much progress we make on inflation, while keeping the labor market from weakening.”
I looked back in the Fed’s history to try to tease out when the Fed had surprised the market with rate cuts. Typically a surprise cut is done at an emergency meeting and none of those dates are times we as investors want to cheer on. Here the dates of surprise cuts at emergency meetings:
March 15, 2020
March 3, 2020
October 8, 2008
March 16, 2008
January 22, 2008
August 17, 2007
September 17, 2001
October 30, 1987
Here are the instances of surprise cuts without an emergency meeting:
September 18, 2024
April 18, 2001
January 3, 2001
I think the key is that the Fed needs to be signaling to the market that they are offsides and need to be anticipating more rate cuts. Nothing good happens to the market when it gets surprised with a cut.
