Is Inflation Finally Cooling Down?


Key learning points

  • August Consumer Price Index (CPI) data was released early Tuesday morning, showing headline inflation rose 0.1% and core inflation 0.6% in August.
  • With these latest results, it’s no surprise that some Federal Reserve presidents are claiming that interest rates could rise above 4% and stay there until next summer.
  • Ahead of Tuesday’s release, economists pointed to several signs, such as falling rents, to suggest inflation is cooling down
  • Experts predict the Fed will hike rates 0.5% to 0.75% at its September meeting, fueling fears of a recession among investors and consumers

Last month, officials released data showing that the consumer price index fell further than expected in July, causing a momentary relief in the stock market. Over the past week, a fearful market saw stocks rise cautiously as a weaker dollar and the specter of lower prices continued the rally. On Friday, all three big averages recovered to break a three-week release streak.

Experts and investors see August inflation data as key to determining whether (or how high) the Federal Reserve will raise interest rates at its September 20-21 meeting. As Tuesday’s release approached, economists were forecasting a 0.5% to 1% increase.

Now the data is in – and it’s not good news for investors. With prices rising 0.1% in August, the nominal annual interest rate has reached 8.3% over the past 12 months. That’s less than last month, but higher than analysts’ expectations, which predicted a 0.1% decline.

Expectations Coming In: Is Inflation Cooling?

The Consumer Price Index (CPI) is a key inflation measure for determining the overall trajectory of the US economy. (Inflation is a gradual rise in prices, or the decline in a dollar’s purchasing power, over time.)

The Fed tends to focus on two parts: the headline figure, which looks at inflation across the board, and the core figure, which excludes food and gas prices. (Both food and gas are stats known for their high volatility.)

Ahead of Tuesday’s inflation report, experts speculated that August inflation data would play a role in the Fed’s decision to raise interest rates in September. It’s not just the headlines that matter – the data inside gives a sneak peek at how different sectors of the economy fare against inflationary headwinds.

Wall Street broadly expected the aggregate CPI to fall about 0.1% month-on-month in August. That would reduce inflation by 8-8.1%, compared to 8.5% in July. The core CPI projections were slightly higher, with gains of 0.3% after weeding out the recent declines in energy. All in all, economists broadly forecast core CPI to hit 6% year-over-year.

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Nobel laureate economist Paul Krugman tweeted sunday that he based inflation expectations on sluggish rents. In particular, he noted, “Rents — market rents and imputed rents for owner-occupied homes — are the main drivers of all measures of core inflation.”

More broadly, many have cited falling gas prices as the main driver of falls in inflation. Between mid-June and Monday, gas consumption dropped from $5.01 to just $3.71 per gallon of unleaded.

So, is inflation cooling? The latest CPI data

The consumer price index was released at 8:30 a.m. ET this morning. It showed that prices have risen by 8.3% in the past 12 months to the end of August.

The story was even worse for core inflation, which removes volatile products like food and energy. It increased by 0.6% to bring the annual rate to 6.3%.

There was a major decline in energy commodities such as gasoline and other fuel oils, but a rapid increase in energy services such as electricity and mains gas.

The increase was also driven by a significant rise in prices for food, medical care, shelter and new vehicles.

In general, prices are rising more slowly than they have been, but they are still rising.

Officials worry ahead of Tuesday’s inflation report

In its fight against inflation, the central bank has already raised interest rates this year to a range of 2.25%-2.5%. Officials had already indicated they were willing to raise interest rates by a further 0.75% in September ahead of Tuesday’s inflation report to curb economic growth and lower prices.

But the Fed may not stop there.

Esther George, president of the Federal Reserve Bank of Kansas City, suggested in a recent interview with Bloomberg Television that interest rates could rise above 4% and stay there for several months.

Her statement runs counter to investor expectations that the Fed will approach – but not exceed – 4% next summer before cutting interest rates again.

George’s comments give numbers to the Fed’s intention to curb inflation completely, rather than pull back at the first sign of lower prices.

On Friday, Loretta Mester, president of the Federal Reserve Bank of Cleveland, reiterated her endorsement.

Mester warned that she “doesn’t have enough evidence right now to even conclude that US inflation has peaked”.

In addition, she believes that “the Fed will have to do a lot more to get that inflation data on that downward path…. What I’m reading now is that we should probably get the Fed’s nominal interest rate slightly above 4% early next year and keep it there through the year.”

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Interest rate fears fuel recession fears

It is precisely this line of thinking on the part of the Fed that continues to fuel consumer and investor fears of a recession – a fact Mester acknowledges.

She added that hopefully the Fed will raise interest rates “in a way that the economy does not go into a deep recession.” At the same time, she admitted that the process “will be somewhat painful, and it will feel painful.”

Still, she believes – along with George – that this temporary pain will ease inflationary pressures in the long run.

What Tuesday’s Inflation Report Means for Interest Rates, Recession Fears

Tuesday’s inflation report capitalizes on these beliefs, while also addressing fears of a recession. Given how stubbornly high prices remain, Tuesday’s numbers are unlikely to allay Fed concerns, if George and Mester’s statements are any indication.

As such, it remains to be seen how high the Fed will raise its short-term interest rate in September. While the federal fund rate only directly affects the interest rates banks charge each other for short-term loans, its effects seep into a variety of business and consumer debt, such as auto loans, mortgages, credit cards, and business loans.

Higher interest rates, in turn, slow economic accelerations and can even trigger recessions — or at least recession fears — if they rise too high and too quickly.

Prior to Tuesday’s release, Wall Street estimated that the central bank would raise interest rates between 0.5% and 0.75% based on inflation data. Now that the numbers are in, an even higher number could be a possibility.

Cooling inflation may not be enough

However, there is no guarantee that August inflation data matters at all. Only time will tell what measures the Fed calculates for this month’s rate change.

For example, some economists predict that food, rent and gas prices could play a big role in the Fed’s decision.

Others suggest that, regardless of CPI, recent labor market and unemployment data is reason enough for the Fed to remain aggressive through at least September.

Ironically, economists also note that lower inflation in some areas could prolong inflation across the economy.

Especially as falling gas prices leave more money in consumers’ wallets, they can increase spending elsewhere. That could lead to higher prices elsewhere in the economy, fueling inflation as the economy and labor market continue to grow.

(While with OPEC’s recent announcement to support prices by cutting production, today’s lower gas prices aren’t guaranteed either.)

What does this mean for investors?

Stock market volatility kicked off last week as investors prepared for Tuesday’s inflation report and September’s Fed meeting. While fears and recessionary fears played their part, prices (and sentiment) were supported by a weaker US dollar and good news from the Ukrainian military.

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As of Monday, investors seemed more optimistic than not. All three major indices closed their fourth consecutive gains session, while government bond yields remained mixed.

Still, the combination of interest rate hikes and inflation continues to affect investors’ prospects.

Typically, rate hikes dampen investment gains because companies find borrowing and expanding more expensive. On the other hand, skyrocketing inflation also decreases investment value as consumers spend less and business expenses increase.

That puts investors in a tight position, with two separate but related forces simultaneously weighing on earnings. While investors tend to view rate hikes negatively (as they did in the spring), recent hikes have been better received as record high inflation and recession fears weigh on corporate earnings.

As a result, some of this year’s massive stock market declines leveled off over the summer, with some eventually returning to black. Others, especially historically volatile assets such as technology stocks and cryptocurrencies, are holding up well in bear market territory.

This recent optimism quickly dissipated on Tuesday morning, with the poor inflation performance and the prospect of a further rate hike giving markets a momentum. The S&P 500 continued to fall all morning and is down 2.75% at the time of writing.

Whether inflation cools or not, is here for you

Ultimately, August’s CPI data is unlikely to have a major impact on the Fed’s decision to raise rates. After all, it’s not ifbut one How much. In a similar vein, the Fed’s response to CPI data is unlikely to be enough to single-handedly boost investor fortunes or dampen market volatility in these uncertain times.

And that’s exactly why is here.

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