Decline in Inflation So Far:
Origins and Initial Actions:
- High inflation resulted from strong demand meeting pandemic-limited supply.
- The Federal Open Market Committee raised the policy rate in March 2022 to address inflation.
- The goal was to slow demand growth, allowing supply to catch up.
Headline PCE Inflation:
- Peaked at 7% in June 2022, then declined to 3.3% by July 2022.
- Global events, like Russia’s war against Ukraine, influenced these changes.
- Headline inflation reflects the direct experience of households and businesses.
Core PCE Inflation:
- Excludes volatile food and energy prices.
- Peaked at 5.4% in February 2022, then decreased to 4.3% by July.
- Two months of positive data is just the start; more is needed to ensure sustainable decline.
- The goal is to achieve price stability.
Core Goods Inflation:
- Has seen a significant decline, especially for durable goods.
- The motor vehicle sector exemplifies this trend, with prices spiking during the pandemic due to demand-supply imbalances.
- As the pandemic’s effects lessen, supply improves, and demand decreases due to higher interest rates.
- Restrictive monetary policy is essential for continued progress.
Housing Sector Inflation:
- Interest rates greatly influence this sector.
- Mortgage rates doubled in 2022, leading to decreased housing starts, sales, and house price growth.
- Growth in market rents began to decline.
- Measured housing services inflation, reflecting all rents, has started to decrease but lags behind market changes.
Nonhousing Services Inflation:
- Makes up over half of the core PCE index.
- Includes services like health care, food services, and transportation.
- Inflation in this sector remained stable since liftoff but has shown a decline over the past three to six months.
- This sector is less affected by global supply chain issues and is less sensitive to interest changes.
- The labor-intensive nature of these services and a tight labor market have influenced inflation here.
- Restrictive monetary policy will be crucial for balancing supply and demand, reducing inflation in this sector.
- The unwinding of pandemic-related distortions will continue to reduce inflation, but restrictive monetary policy will play a significant role.
- Achieving a 2% inflation rate will likely need a period of economic growth below the trend and some relaxation in labor market conditions.
- Restrictive monetary policy has led to tighter financial conditions, pointing to growth below the trend.
- Real yields have increased, bank lending standards have become stricter, and loan growth has decelerated.
- Indicators like slowed industrial production growth and reduced residential investment expenditure suggest a slowing economy.
- However, there are signs that the economy might not be cooling as anticipated, with GDP growth exceeding expectations and consumer spending being particularly strong.
- A resurgence in the housing sector and consistent above-trend growth might necessitate further monetary policy tightening.
The Labor Market:
- The labor market has been rebalancing over the past year, but the process isn’t complete.
- Labor supply has improved due to increased participation from workers aged 25-54 and a return to pre-pandemic immigration levels.
- The labor force participation rate for prime-aged women reached a record high in June.
- Although job openings remain high, they are decreasing, and payroll job growth has significantly slowed.
- Total hours worked have remained stable, and the average workweek has returned to pre-pandemic levels, indicating a normalization in labor market conditions.
- Wage pressures have reduced, with wage growth slowing across various measures. However, real wage growth has been on the rise as inflation decreases.
- The expectation is for the labor market rebalancing to persist. If labor market tightness doesn’t ease, it might necessitate a monetary policy intervention.
There has not been a great move in Fed pricing. However, there is a dovish response to the speech despite the Fed Chairs insistence that the inflation still needs to come down and the economy remains strong with GDP.
This article was written by Greg Michalowski at www.forexlive.com. Source