Blog Strong Core CPI Inflation Won’t Sway the Fed From Rate Cuts We think the Federal Reserve will look past stronger-than-expected consumer price increases in June and July.
U.S. core Consumer Price Index (CPI) inflation was firmer than expected in July, increasing 0.3% month-over-month, similar to June’s gain, and the year-over-year rate ticked up to 2.2%. We have been flagging the risk that businesses could pass on the higher costs associated with import tariffs more aggressively, and early evidence suggests this is happening. We now expect the year-over-year rate of core CPI to drift up to 2.5% over the next several months. While the strong June and July readings are awkward for Federal Reserve officials, who are likely to cut rates again in September and possibly more later this year, we think they will look past it given that much of the firming is happening in retail goods categories subject to tariffs – and therefore temporary. Moreover, the news that the U.S. is removing certain products from the list subject to Chinese import tariffs set to go into effect on September 1, and delaying to December 15 tariffs on items that can’t be easily sourced from other countries – including cellphones, laptop computers, video game consoles, certain toys, computer monitors, and certain footwear and clothing items – could further ease related inflation concerns. With inflation expectations more or less anchored, the risk that tariffs kick off an inflationary spiral appears much lower than the downside risks to real growth from trade and tariff uncertainties and slower global growth. Inflation marches on despite ‘Prime Day’ discounts The firming in July came despite reports of broad-based sales promotions around Amazon Prime Day on July 15, with businesses appearing to pass on a greater portion of the higher goods import tariffs. The pace and magnitude of consumer price adjustments have been somewhat more aggressive following the May tariff announcements, prompting us to incorporate a somewhat higher rate of pass-through for the wider range of goods subject to tariffs after the “Tranche 4” announcement on August 1 (despite some products being removed from the list and the others delayed until December). We now expect retail goods inflation to reach 1% over the next several months – a pace that hasn’t been witnessed since early 2012. Services categories hold firm Meanwhile, core services prices gained 0.3% month-over-month, with support from solid gains in shelter services. Lower vacancy rates and the lagged effects of rising wages and higher interest rates (which make owning a home comparatively less affordable) are supporting housing inflation. Eventually, the more recent decline in rates and a slower pace of wage gains will help cool CPI-reported housing services inflation; however, based on the historical lags, inflation in these categories should hold firm over the next several quarters. Medical, airfare, and lodging inflation was also firm. Price changes in lodging are notoriously volatile and tend to mean-revert over time, while the lower cost of jet fuel will moderate airfares over the coming months. However, the faster pace of medical services inflation should stick. Inflation in this category was notably weak in 2017 after lower payout rates from government-administered programs spilled over into private insurance payments. However, administrative changes in 2018 reduced the managed disinflation in Medicare and Medicaid prices and have allowed medical service providers to charge higher prices to private insurance. Used car inflation stays strong after a price spike in June While used car prices were strong in June and July, price trends in the wholesale auction market have since cooled, pointing to slower used car inflation over the next several months. Looking ahead to next year, the recent drop in steel prices should further moderate new and used car inflation. Bottom line? We now expect the year-over-year rate of core CPI to reach 2.5% over the next several months, with businesses increasingly passing the cost of tariffs on to consumers. However, firmer inflation shouldn’t change the easing bias of Fed officials, who will likely be more worried about mounting downside risks to real economic growth. We expect the Fed to look past the recent price gains as it contemplates further interest rate cuts this year. For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page. ACCESS NOW Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.
Blog The ECB Is Not Done Yet The European Central Bank raised its policy rate, and more hikes are coming.
Blog Fed Seeks to Balance Competing Risks Investors face mixed signals between the Federal Reserve’s policy guidance and recent economic developments.
Blog Trying to Make Apple Juice From Oranges: The Problem With Comparing Market Pricing and Fed Projections As investors seek to pinpoint market expectations for Federal Reserve policy, it’s critical to consider not just rate projections and derivatives pricing, but the degree of uncertainty and distribution of outcomes.
Viewpoints The U.S. Debt Ceiling Debate: Expecting Resolution, Appreciating the Stakes We believe Congress will reach an agreement before the debt limit is reached, but markets could face turbulence later this year.
Strategy Spotlight Income Fund Update: A New Bond Cycle Is Dawning We believe fixed income markets offer higher yields and better valuations than in years, and we’ve positioned the Income portfolio to further benefit amid potential for volatility and a weakening economy.
Blog Dollar Strength: Sum of All Fears The dollar is set to weaken as fears over last year’s shocks abate.
Blog European Outlook: Less Downside Now, But Caution Still Warranted Focusing on high quality and liquidity when taking risk in portfolios will be key in 2023, as pressure on monetary policy remains intense.
Blog U.S. Inflation Eased More Than Expected in November as Fed Eyes Pause in Rate‑Hike Cycle Next Year Falling prices for cars and holiday discounting contributed to softer U.S. inflation, creating more room for the Fed to potentially dial back its hawkish stance.
Blog What’s Behind the Slowdown in U.S. Inflation Core inflation came in below expectations for October and should moderate in 2023, but likely with bumps in the road ahead.
Blog Surging September CPI Bolsters Case for Further Outsize Fed Hikes Core inflation in the U.S. outpaced expectations for September and may fortify the Federal Reserve’s hawkish resolve.