With inflation slow, the Fed is done hiking, and now plans 75bps in cuts next year

Markets liked what they heard from the Fed yesterday, with the Fed pausing on rate hikes again and talking a lot about 75bps in rate cuts next year.

As a result, the major equity indices gained over 1% (the Dow hit a record high) and 10-year Treasury rates fell nearly 20bps to 4.0% (it’s under 4% this morning).

What suddenly changed? Importantly, we’ve seen continued progress in getting inflation lower.

Inflation slowdown has been broad-based

On Tuesday, we got new inflation data that showed headline CPI slowed to just 3.1% YoY now (chart below, light blue line). That’s from a peak of 9.1% YoY in mid-2022. Even core inflation (everything except food and energy) has slowed from a peak of 6.6% YoY to 4.0%.

Data shows the price slowdown is broad-based. For example:

Energy prices have had a negative contribution for much of the year (black bars), as oil and gas prices fell (and keep falling) as disruptions caused by the war in Ukraine were resolved.
The war in Ukraine also caused supply disruptions for Food, increasing its inflation contribution last year (green bars) – along with strong wage growth in the sector. But with those disruptions resolved and wage growth slowing, the inflation contribution from food has shrunk too.
The broader wage growth slowdown explains why the contribution from Core services ex housing (mostly wages) has faded (blue bars).
Core goods have been adding nothing to inflation (red bars) in recent months, as the manufacturing and housing recessions hurt goods demand and healing supply chains boosted supply.

Inflation expected to slow even further in 2024

And inflation is expected to keep falling next year. As we show below:

New rents show housing inflation is set to slow further

As the chart above shows, Housing (purple bars above) remains the biggest driver of inflation. That’s because of high rents, which are being held up by strong home prices and high mortgage rates keeping would-be homebuyers as renters, adding to rent demand. Recent research shows that it takes a year for new rents to filter into the rents CPI.

But if we look at a BLS index of “new rents” that only looks at new leases being singed, we see rent has been slowing since Q2 2022 (chart below, blue line, pushed forward 1 year). So, with rents CPI only turning down in March 2023 (purple line), there’s disinflation in the pipeline.

Cooling labor market means wage growth slowing more

Another big driver of inflation that worries the Fed is wage-driven inflation. That’s because wages rarely go down, and can add to costs, causing companies to raise prices even further to cover new costs – creating a “wage-price” spiral or feedback loop.

But data also shows wage growth has been slowing since Q2 2022 (chart below, blue line). In addition, the quits rate is slowing (purple line, pushed forward 2 quarters), showing people are nervous they won’t find another job, which is usually a sign wages will also keep slowing.

That means wage growth could easily slip below 4% next year. After productivity gains, the incremental costs to companies could be back down near the Fed’s 2% inflation target.

Between healed supply chains and weak demand, we could see some core goods deflation

Core goods should also keep downward pressure on inflation.

Core goods price growth has already slowed to zero (chart below, red line) because goods demand has cooled as consumers increasingly spent on services and the supply chain disruptions caused by the pandemic have now fully reversed.

With the NY Fed’s Global Supply Chain Pressure Index negative for nine of the last 10 months (black line, pushed forward 9 months), it suggests core goods could fall into outright deflation.

Zero inflation doesn’t mean prices will go back to where they were

Unfortunately, even if inflation falls to 0%, that doesn’t mean prices fall. They’re just been flat compared to one year ago. So get used to the current prices being the new prices from now on. Your parents will know how that feels.

But it’s not as bad as it seems. Wages are up too.

In fact, wages are up even more than prices. They’ve increased 22% since February 2020 (chart below, dark blue line), compared to inflation, which has risen 19% (chart below, light blue line).

It’s all relative. You can afford more than before, just not as much as you thought.

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Original: Earnings Feed: Inflation to Keep Slowing in 2024, Supporting Fed Cuts