While some of the recent positive news from the US economy—particularly the latest strong jobs report—may be seen as negative from the Fed’s perspective, everyone can agree that at least one measure is improving: inflation. Yesterday, the Bureau of Labor Statistics released the November reading of the Consumer Price Index. The data showed inflation slowed more than expected, reaching an annualized rate of 7.1 percent, which is markedly lower than October’s 7.7 percent. Core consumer prices—which exclude more volatile food and energy products—also saw a noteworthy decline. On the surface, it seems the Fed’s aggressive rate increases are showing results, and inflation is decelerating.
Energy can have a tangible effect on headline inflation, which has definitely been the case in recent memory when crude oil prices soared to over $100 per barrel and gas prices rose alongside. Investors are watching energy markets closely this week after the European Union’s ban on Russian oil finally took effect on December 5. Western nations agreed on a price cap of $60 per barrel for Russian seaborne oil in an effort to curb the financing of its war with Ukraine. The ban is likely to result in higher exports to countries like India and China, while European nations may attempt to find other sources for their energy needs. A formidable task amid the colder winter months. WTI oil prices continued their rebound today, climbing to over $77 per barrel this morning.
The top-line decline in consumer prices has given the Federal Reserve some wiggle room, particularly as it continues to broadcast that it is close to reaching its terminal rate. On cue, today the Fed announced a half-percent increase in its benchmark rate to a range of 4.25 percent to 4.50 percent. Investors widely expected the move, with fed funds futures accurately predicting the shift. However, the data also shows the market is expecting one or two more quarter-point moves early next year before forecasting that the central bank will actually start cutting rates in late-2023. This is in stark contrast to Fed officials’ own projections that the overnight rate would reach around 5.1 percent at the end of next year. Additionally, officials have repeatedly broadcasted that rates will be higher for longer and seem adamant about reaching their inflation target even if the broader economy suffers. Meanwhile, the financial markets believe the Fed will be forced to cut rates if and when the US economy enters a slowdown. That is an important divergence. Stock markets may be going head-to-head with the Fed next year and the odds aren’t good for investors. There’s an old adage in the financial industry, “Don’t fight the Fed.”