A peak in US inflation opens the door to smaller Fed hikes in December

Kieran Davies

Coolabah Capital

US core inflation and wage growth have both peaked, but remain high, with the split of inflation showing persistent, broad-based demand-driven gains in consumer prices. 

After likely hiking by 75bp this week, some FOMC members would like to soon raise interest rates in smaller increments, but broad-based price gains suggest that the committee may not clearly signal such a shift to the market until the December policy meeting, by which time it will have more readings on unemployment and inflation and an updated staff outlook.

Normally the peak in US interest rates is relatively short, but this time is likely to be different given the Fed is dealing with the largest shock to inflation in decades and with some risk that high actual inflation feeds into a structural increase in expected inflation, something that would trigger much higher interest rates. 

Growth in the Fed’s preferred measure of wages, which is the private-sector wages employment cost index (ECI) excluding incentive payments, peaked at 5.8% in annualised terms in Q4/Q1 and has slowed to 5.2% in Q3 (average hourly earnings have also peaked, but are more volatile and can be revised).

The Fed’s preferred measure of underlying inflation, namely the core PCE deflator, peaked at 5.3% in annual terms in Q1 and has slowed to 4.9% in Q3. However, annualised inflation is still high at 4.9% in Q3 and the Fed will likely bump up its near-term forecast profile for inflation when it revises its outlook in December.

Although core inflation has peaked, the trimmed mean core PCE deflator, which captures the breadth of price changes, is still growing strongly, up 5.3% in Q3, indicating that the prices of most goods and services are posting large gains. 

Similarly, the San Francisco Fed’s estimation of the drivers of inflation suggests that the peak in inflation has been driven by an improvement in supply factors, consistent with the large improvement in global supply chains, but with the contribution of demand factors to inflation still high.  

US wages growth has peaked ...
... as has core inflation ...
... although the trimmed mean deflator indicates that the bulk of prices are still increasing strongly 
... and the Fed's analysis suggests the moderation in inflation has been driven by supply factors with demand factors still strong 

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Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...

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