The markets were pleased that US Federal Reserve Chairman Powell has recently been speaking frequently of “disinflation” having set in, ie that inflationary pressure is easing. However, the most recent data only partially confirm this. Accordingly, the Fed will probably raise interest rates several times.
Bad start to the new year
Hopes of a rapid further decline in inflation suffered a noticeable dampener at the beginning of 2023. As measured by the consumer spending deflator (the Fed’s preferred price index), prices rose by an unexpectedly strong 0.6% in January. The inflation rate rose again for the first time since mid-2022 and was 5.4%; this is still well above the Fed’s 2% target.
Of particular concern is that this is not due to a stronger increase in the always highly volatile prices of energy and food. In fact, even after eliminating these two groups of goods, prices rose by 0.6% (calculated on an annual basis by 7.1%), after 0.4% in December and 0.2% in November (Figure 1). The core inflation rate measured in this way has remained around the 5% mark since the end of 2021 and is therefore far too high.
“Super Core” way too high
The prices of the goods contained in this core rate show different trends. The rise in prices for goods (excluding energy and food) has already slowed noticeably. Because these had increased significantly during the pandemic due to high demand and simultaneous supply problems. As these special factors become increasingly less important, commodity prices have risen more slowly or even fallen in recent months. Among the services, rents are a special case. Although these are still rising sharply, a trend reversal is likely this year because rents for new contracts are already falling according to data from the private sector, which should be reflected in the overall portfolio with a certain delay.
However, according to its boss Powell, the main focus of the Fed is on services without housing, which thus define a “super core” inflation rate that accounts for about 56% of the core rate. There is no sign of a calming down of the upward trend in prices (Figure 2). In fact, the latest values are even more likely to indicate stronger price pressure again.
„Trimmed Mean“
In recent years, alongside traditional core inflation (which excludes energy and food prices), a whole range of alternative core measures have come into vogue, the ‘Super Core’ index shown above being just the most recent example. This procedure raises the suspicion of a certain arbitrariness as to which of the groups of goods is currently taken into account or excluded. A more systematic method for excluding goods with extreme price movements is the so-called “trimmed mean”. The Dallas Fed calculates this for the consumer spending deflator. Of the 178 groups of goods in the basket, the 24% with the lowest price increases and the 31% with the highest price increases are eliminated each month [1]. According to the statisticians, the mean value of the price changes of the remaining goods reflects the underlying price trend better than alternative core measures.
Shortly after the release of the deflator, the Dallas Fed calculates the trimmed mean of inflation on a 1-, 6- and 12-month basis (the rates of change are each published on an annualized basis). It shows that 6-month and 12-month inflation have been moving in a rather narrow corridor of around 4.7% since spring 2022 (Figure 3). There can therefore be no talk of an abatement of the underlying price pressure. The short-term 1-month view naturally fluctuates more and has even indicated increasing inflationary pressure in recent months.
Conclusion: Way to 2% is getting longer
All of this suggests that the Fed has yet to make any meaningful progress in containing inflation. Although headline inflation has increased by around 11/2 Percentage points lower after energy prices or the prices of some goods particularly affected by supply chain problems have fallen again. However, these volatile price movements mask the underlying inflation trend, which is still far too high and has not slowed down significantly so far. Our overview of various core measures suggests that the inflation trend is likely still above 4%, well above the central bank’s 2% target. The Fed will hope that the effects of the change in monetary policy have not yet become apparent, simply because of the usual delays in taking effect, and that price pressure will then ease noticeably as the year progresses. If this does not happen, the Fed has apparently not cooled demand sufficiently. Significantly stronger interest rate hikes than previously expected (our forecast: three further hikes by June by 25 basis points each to 5.50% for the upper end of the key interest rate corridor) would then be likely.
[1] The groups of goods are weighted according to their share in the basket of goods. The “trimming” by 24% or 31% was determined in such a way that the weighted average of the inflation of the remaining goods is as close as possible to a statistically determined trend value of the overall inflation.
Commerzbank Research
Commerzbank Research