"Federal Reserve Chair Jerome Powell signaled in Congressional testimony this week that the Fed is likely to cut interest rates later this year. From the Fed's perspective, this inflation report provides another confirmatory data point to proceed with the rate cuts. The Consumer Price Index (CPI) report for June released this morning reveals encouraging progress on inflation. Core CPI fell more than expected to a 0.1% increase month over month. In particular, the deceleration in shelter inflation is promising, though the shift might reflect the reversal of anomalies that boosted shelter inflation in May. Headline CPI was negative on the month, driven by a significant fall in energy prices in June. On a year over year basis, Core CPI rose by 3.3%, the lowest reading since April 2021.
While the recent low readings of measured inflation are encouraging, putting too much stock in noisy monthly data series can lead to mistaken diagnoses of the economy. Stepping back, across a range of measures, underlying inflation appears to be relatively stable at a level that is higher than the Fed’s stated inflation target. This challenge will become even more clear in the upcoming data as the denominator in year-over-year comparisons picks up the extremely low inflation readings of the second half of 2023. Surveyed inflation expectations remain relatively stable at approximately 3%, materially above the pre-Covid norm. Market-based measures of inflation expectations, such as break evens, also remain materially higher than pre-Covid. Indeed, the Fed’s own summary of economic projections shows that the Fed expects Core PCE inflation to be higher than its target through the end of next year. With scant evidence that higher interest rates are threatening the Fed’s employment mandate or the economy at the aggregate level, the Fed should be wary of signaling the start of a cutting cycle that could threaten to stimulate financial conditions, support persistent inflationary forces, and weaken the market's perception of its credibility on its inflation mandate."
- Dan Katz, Manhattan Institute Adjunct Fellow.
Katz previously served as a senior advisor at the United States Department of the Treasury. He has published widely on economic policy, international affairs, and financial markets in City Journal, The Wall Street Journal, Bloomberg, the Financial Times, Barron’s, National Review, The Hill, and the Center for Strategic and International Studies. For a list of his previous writing at the Manhattan Institute, click here.
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