Submitted by Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast
In the economic indicators game, the monthly employment report has always been the champion among all economic indicators. The monthly payroll numbers along with the unemployment rate conveys much about the state of the macroeconomy and offers clues to both bond and stock investors. It remains one of the most watched and followed. Since the forty-year high in inflation last year, and early inaction by the Fed, inflation indicators are now in the running for the most important and followed. From 2000 to 2021, the highest rate of core inflation was 2.93% and that occurred in the second half of 2006, just before the Great Recession. Core strips out the cost of food and energy and is a preferred measure of underlying inflation. Outside of that run-up in 2006, the highest core rate was just over 2%. So, inflation was contained, and as a result, inflation reports such as the Bureau of Labor Statistics Consumer Price Index did not attract as much attention or excitement. Since the headline 9.1% CPI peak of last year, interest and monitoring of the CPI have increased considerably. It is one of the reports that provides insights on prices and ultimately Fed decisions on interest rates.
“Data dependent” is a phrase that has been used by Chairman Powell over the past several FOMC meeting regarding Fed decisions on interest rates. This means that the data will ultimately determine Fed decisions, which is how it usually works, and supposed to work. So, if inflation comes in hotter than expected, this could result in either a pause or interest rate increases. If inflation is weaker than expected, this might produce a decision that would reduce interest rates. The Fed paused on the decision last week, holding the Fed Funds rate at 5.5%. However, the “dot plot” was revised upward, indicating that rates would be “higher for longer”. As mentioned in a recent column, the Fed has no other choice for such a narrative. It must be hawkish, and that was the tone of the last meeting. Nonetheless, there was a pause in interest rates, and now the next decision moves to November.
On data dependency, the last BLS report on the Consumer Price Index (CPI) showed that the annual rate of inflation increased from 3.2% to 3.7%. This was slightly above the consensus estimate of 3.6%. The monthly increase was .6%, the highest monthly increase in more than a year. The increase in the monthly and annual rates was due to gasoline, accounting for more than half of the monthly increase. The cost of shelter was also a major contributor to the monthly increase. The good news was on the core rate, however. The core rate came in a little hotter on a monthly basis but declined from 4.7% to 4.3%. When you remove the cost of food, energy, shelter and used cars, the annual rate of inflation declines to 3.2%.
How does this compare to a recent period? Around the Great Recession and Fed policy at the time, the core rate of inflation moved from 2.93% to .6% in almost four years. This also required an unemployment rate to reach 9.9%. In the current regime, the core rate peaked at 6.64% back in September 2022, and has already declined to 4.39% in August. In less than a year, the Fed has already produced a core rate decline that equals the decline observed in 4 years around the Great Recession, and with only 2/10ths increase in the unemployment rate this time.
Another important indicator for the Fed is average hourly earnings, and here, the trend is in the right direction. In 2020, during the height of the pandemic, average hourly earnings were up 7.8%. We then saw the growth in earnings fall off the cliff, declining to 1.47% in April 2021. As the economy continued to reopen and labor shortages intensified, average hourly earnings increased by almost 7% a year later in April 2022. Since then, however, average hourly earnings changes have been on the decline. The most recent data release shows a year-over-year change of 4.5%.
Declining core prices, along with softening average hourly earnings, will likely produce another pause for the Fed in November. The data will drive that decision. While it may be difficult to realize, progress is being made. An option to increase puts the possibility of another rate hike on the table, but the data will ultimately show that we will likely see another pause.