On Wednesday, another fully unexpected US CPI data plunged Wall Street into a state of anxiety. Regarding this, Nick Timiraos, the Federal Reserve's mouthpiece who believed that the report would have significant implications for the Fed's decision-making before the release of CPI data, also issued a latest article on Thursday morning Beijing time stating that the current Fed rate cut is no longer just a matter of "when", but also includes the suspense of "whether to cut or not"!
The renowned journalist from the Wall Street Journal, known as the "New Federal Reserve News Agency" in the industry, said that robust recruitment data and the prospect of inflation rates approaching the Fed's target of 3% instead of 2% in the long term may raise doubts about whether the Fed can still cut interest rates later this year without evidence of a greater economic slowdown.
Did the last mile turn into the Long March?
Timiraos pointed out that Federal Reserve officials, including Federal Reserve Chairman Powell, seemed to have had a smooth ride at the beginning of this year: the rate of inflation cooling by the end of 2023 exceeded the expectations of most economists both inside and outside the central bank, especially considering unexpectedly strong recruitment and economic growth.
The widespread downward trend of inflation once gave people reason to believe that the "last mile" of the fight against inflation was not difficult: inflation (core PCE data), after dropping from a peak of 7% in June 2022 to 3% by the end of 2023, may gently fall back to the Federal Reserve's target of 2%, without experiencing the "pain" that Powell had warned about in the labor market.
But now, the third consecutive month of price data exceeding expectations may prompt officials to return to an uncertain waiting mode.
Timiraos suggests that the latest data actually presents two different possibilities:
The first possibility is that the Federal Reserve's expectation that inflation will continue to decline - but in an imbalanced and "bumpy" manner - has not changed (currently only the bumpy magnitude has become greater). In this situation, the Federal Reserve may still cut interest rates this year, but it will delay and slow down the pace of rate cuts.
The second possibility is that the inflation rate is not "bumping" on the road to 2%, but will completely remain at a level close to 3%. In this situation, if there is no evidence that the economy is significantly slowing down, it may completely eliminate the reason for interest rate cuts.
Current Inflation Situation: Should we interpret it as "bottom-up" or "top-down"?
Timiraos believes that in order to determine which of the above two possibilities is more biased, including Federal Reserve officials and market participants, it may be necessary to first unify a "caliber": whether to interpret the current sticky inflation from a "bottom-up" or "top-down" perspective? What are the driving factors of inflation?
Prior to this, some officials and economists outside the Federal Reserve adopted a "bottom-up" analysis approach to inflation. They believe that the high inflation in the service sector in recent months reflects the legacy effects of disruptions related to the pandemic, rather than the overheating of the labor market. As the imbalance in the labor market subsides, inflation in the service industry should cool down.
Timiraos mentioned an example of car insurance - car insurance has been experiencing unusually large increases recently. Timiraos believes that this may reflect the situation where insurance companies increased premiums due to the skyrocketing cost of replacing a crashed vehicle after the skyrocketing car prices a few years ago.
However, in fact, Timiraos stated that some Federal Reserve officials have also begun to be skeptical of this bottom-up analytical approach and instead believe that a top-down approach should be adopted. They are concerned that the economy and labor market may need to further slow down in order to prevent companies from driving more price increases.
Dallas Fed Chairman Lorie Logan stated last week that the significant increase in US inflation in January may not be an anomaly. She believes that the distribution of the entire price change has shifted towards greater increases.
In addition, Richmond Fed Chairman Barkin also pointed out that he is concerned that even if the biggest price increases are in the past, companies and business owners may once again muster the courage to raise prices to increase revenue.
Harvard economist Jason Furman said, "Many 'bottom-up' analytical perspectives largely overlook the need for 'top-down' stacking, as some things are more expensive because people can already afford these more expensive things."
Has the pace of predictions from the Federal Reserve and Wall Street been disrupted?
Anyway, the latest CPI report is likely to have disrupted the pace of the Federal Reserve and many Wall Street institutions.
Timiraos highlighted a speech by Powell during his March congressional semi annual testimony. Powell stated at the time that Federal Reserve officials were "not far away" from obtaining the confidence needed to lower interest rates by mid year. One or two more benign price readings may be enough for officials to conclude that interest rates can be readjusted to lower levels.
Powell also said at the time, "We don't want a situation where the good inflation data for the six months of last year cannot accurately reflect the underlying inflation situation, so we need to act with caution."
It is obvious that Powell and his colleagues have been searching for a credible reason to initiate interest rate cuts. But this reason has not been found in the data so far.
Timiraos stated that due to stronger than expected data for January and February, another data that does not meet expectations will begin to raise more confusing questions, including: what if the Federal Reserve cannot achieve any interest rate cuts this year, and if investors trust the Federal Reserve too much in achieving a soft landing?
Timiraos mentioned that many Wall Street forecasters no longer predict on Wednesday that the Federal Reserve will cut interest rates in June and three times this year. Economists from Goldman Sachs and UBS now believe that the Federal Reserve will cut interest rates twice starting in July and September, respectively. Analysts at Barclays Bank predict that interest rates will only be lowered once this year in September.
Blake Gwinn, interest rate strategist at Royal Bank of Canada Capital Markets, also stated, "The June rate cut is the key to our expectation of three rate cuts within the year. If (June) the rate cut is not achieved, we believe that the first rate cut will easily be postponed until December."