All attention on Tuesday morning’s report of Consumer Price Index inflation for August.
It is likely to drive stocks higher in a continuation of Friday’s advance.
But the report will not change the Federal Reserve’s mind about increasing interest rates again when the central bank’s Open Market Committee meets on Wednesday, September 21.
The CPI data are likely to make the Fed even more resolved to raise rates by a big 75 basis points.
My projection of those seemingly contradictory results–stocks up on “good enough” inflation news but the Fed pushing ahead with an aggressive 75-basis-point interest rate increase on “not good enough” inflation news–comes from my conviction that Wall Street and the Federal Reserve will be watching different elements of the CPI report.
Economists surveyed by the Wall Street Journal are predicting that headline inflation will fall to an annual rate of 7.9% in August from the 8.5% annual rate in July and the 9.1% annual rate in June. The Federal Reserve isn’t quite as sanguine. The Cleveland Federal Reserve bank, for instance, sees headline inflation falling in August to an annual 8.3% from 8.5% in July and 9.1% in June.
As far as the headline inflation numbers–what the government’s statisticians call the all-item index–this is good news. It indicates that inflation may have peaked in June.
But this isn’t the inflation number that the Federal Reserve watches. (In actuality the Fed doesn’t use the CPI inflation index as its inflation index. It uses the Personal Consumption Expenditure Index. The August PCE isn’t due until September 30.)
The Fed watches the core inflation number, which excludes prices in the volatile food and energy sectors. One of the reasons that the headline CPI index is falling is a decline in energy prices (offset by continued increases in food prices.) The Fed won’t set interest rates based on easily reversed downward trends in energy costs.
Especially since the core inflation picture–the core rate excludes energy and food prices–looks very different from the headline number. Those Wall Street Journal economists see the core CPI inflation rate actually climbing in August to an annual rate of 6.1% in August from a 5.9% annual rate in July. The Cleveland Fed sees core inflation in August climbing a bit more steeply to a 6.3% annual rate from 5.9% in July
The key sector pushing core inflation high in August is likely to be the cost of housing. The Fed’s interest rate increases have pushed up the cost of a mortgage and reduced sales and prices in the home purchase market. The likelihood is that rents–and what the CPI calculates as rent-equivalent prices–haven’t fallen by much if by anything in August. The rental market remains really tight and very pricy.
My read is that the financial markets will be happy seeing the drop in the headline rate as a sign that inflation is dropping. And that the Federal Reserve will look at the core inflation rate and see more work–and interest rate increases–ahead.