Is Progress Stalling on the Fed's Inflation Fight?

Is Progress Stalling on the Fed's Inflation Fight?

At a recent meeting, Federal Reserve (Fed) officials left the federal funds target range at 5.25% to 5.50% for the seventh consecutive meeting. Chair Jerome Powell gave no clear indication as to when a rate cut would materialize, repeating that Federal Open Market Committee (FOMC) participants want greater confidence that inflation is moving sustainably toward 2%. We reiterate our call for one rate cut after the election, probably in December. Additional downside surprises in inflation or an unexpected jump in unemployment this summer could put a September cut in play.

Fed projections indicate rate cuts are being pushed out

There were several changes to the Fed’s Summary of Economic Projections. As shown below, the median FOMC participant now expects one rate cut this year, down from March expectations for three cuts in 2024. Whereas eight participants still see two cuts this year, seven see one and four expect none, as illustrated by the “dot plot.” We expected nine participants to anticipate two cuts this year.

Participants now see four cuts in 2025—up from three in March—and another four cuts in 2026, taking us to 3.1%. In essence, cuts are being pushed out, but the total number is the same.

Progress toward disinflation has stalled

To look at data through a historical lens, we like the Inflation Timing Model from Ned Davis Research (NDR), shown below.

There was a very timely buy signal as inflation moved up in early 2021 and a sell signal in July 2022 after inflation peaked. While the model is still in the low inflationary pressure zone, it has been moving higher. In recent months, in our view, thanks to commodity prices, sticky shelter prices, and services.

Shelter costs remain elevated

Shelter prices count for more than 30% of the CPI and they tend to move more slowly than the actual prices of housing and/or rents. In fact, if shelter is removed from the CPI, the rate is only 2.1%, as shown below.

Real-time rents have already dropped quite a bit and now show negative year-over-year growth, as illustrated below. If this trend continues, shelter should continue to decline in coming months, hopefully dragging the CPI down with it.

Some signs of an economic slowdown

We are also watching signs of some economic weakness. Though not widely publicized, these factors could put downward pressure on inflation. For example, the Employment Trends Index shown below has a great record for calling changes in real GDP, and it suggests a degree of underlying economic weakness.

In addition, the NDR Real Monetary, Fiscal, and Exchange Rate Policy Index shown below fell in April, dipping into its most negative zone and suggesting slower growth later this year.

Not surprisingly, given the items mentioned above, the Citigroup Economic Surprise Index has dropped into negative territory and is currently just shy of its bearish level, as shown below.

Finally, in our view, consumer expectations remain fairly weak and are more consistent with a very slow-growing economy versus a vibrant one.

What’s next?

After the Fed’s historically fast tightening cycle, officials have continued to remain “on hold” for longer than initially expected. Plans for six interest rate cuts in 2024 are now down to one cut later this year. The stock market, however, has gotten much more comfortable with the “higher for longer” plan. We believe this is good news for investors, who can now get reasonable rates of return on cash and bonds without sacrificing stock returns (yet). The big question: Will these higher rates eventually send the economy into a recession? While we don’t yet know the answer, it appears things still might be in that Goldilocks state of not too warm and not too cold.

Third party sources and supporting documentation owned and provided by Ned Davis Research 

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