Federal Reserve Chairman Kevin Warsh reaffirmed his vow to “deliver price stability” in a speech on Friday, a day after a second inflation report in as many days highlighted the growing challenge to achieving that goal in the near term.
The US Bureau of Labor Statistics on Thursday released wholesale price data for September, which highlighted the ongoing challenge for the Fed to tame inflation, which continues to run well above its 2% target. The latest Producer Price Index (PPI) report reveals that inflationary pressures for businesses remain highly elevated, as wholesale prices jumped 6.3% year-over-year driven by a significant surge in energy costs that suggests continued upward pressure on consumer prices. That annual increase through last month mark the highest pace in nearly four years.
A day earlier, consumer inflation came in hotter than expected for September. The back-to-back reports strengthen the view that pricing pressure remains persistent and unlikely to fade until the Middle East conflict is resolved.
PPI numbers also suggest that the pickup in inflation this year, largely due to an energy shock linked to the attack on Iran, is starting to spread into the wider economy. Notably, wholesale inflation is now running far hotter than consumer inflation, which rose 3.7% in September vs. the year-ago level. The mismatch suggests that businesses are under greater pressure to pass on higher prices to consumers.
When inflation surged in 2021-2022, PPI quickly ran ahead of consumer inflation, a shift that marked an early point in the ensuring acceleration of prices. The concern is that history is repeating and that the widening gap in PPI over CPI points to accelerating inflation pressure overall.
The Fed raised its target rate by a quarter point last month, but the central bank is expected to stand pat at the upcoming Oct. 28 policy meeting. Fed funds futures this morning are pricing high odds for no change this month. For the December meeting, by contrast, the market expects another rate hike.
The question is whether it’s wise to wait until the end of the year to tighten policy, which may allow inflation momentum to strengthen and make the Fed’s job that much tougher. Whatever the merits of another hike, the consensus view is that doing so just days ahead of the mid-term elections would be a bad look for the Fed, which strives to steer clear of politics. But what’s smart from a political perspective may turn out to be costly for keep inflation contained.
The argument that raising rates threatens economic growth is a weak pushback lately. The Atlanta Fed’s Oct. 15 nowcast for the initial estimate of third-quarter GDP (due on Oct. 29) is on track to post a robust increase in output over Q2.
Part of the US economic strength at the moment is related to AI spending, Warsh said earlier today. “It means we’ve got plenty of tailwinds that are giving some strength and durability to this economy. That sort of momentum is certainly not found everywhere in the world.”
The case for further tightening appears to be strengthening, but the bond market is giving the Fed some space to postpone another hike. The policy-sensitive US 2-year yield continued to ease on Thursday, dropping to 4.74%, or close to 20 basis points below its late-September peak. But even after the latest pullback, this widely-watched yield remains far above the Fed’s current 3.75%-4.0% target range, which suggests investors are still predicting hikes are near.
The bond market has turned patient in recent days, but assuming the calm will extend until the December FOMC meeting is open for debate. Indeed, between now and then new inflation reports are scheduled and it’s getting harder to assume that the incoming numbers will keep the bond vigilantes composed.
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