The Fed Won't Wait for Inflation to Slow to 2%

Alexander Ovchinnikov

Jul 11, 2024

These words were spoken by Fed Chairman Jerome Powell on Wednesday, addressing the U.S. House Financial Services Committee. They came a day after Powell's speech the day before, when he noted the need for "good data" to increase Fed policymakers' confidence that prices are slowing sustainably. And perhaps this data has appeared.

•⁠ ⁠The report published today showed that the growth rate of consumer prices decreased by 0.06% month-over-month (m/m) compared to a 0.01% increase in May. On an annual basis, the growth rate slowed to 2.97% year-over-year (y/y) compared to 3.27% a month earlier and 3.35% in December.

•⁠ ⁠Core inflation, i.e., the consumer price index excluding the volatile prices of food and energy, rose by 0.06% m/m compared to 0.16% in May, and on an annual basis, the growth rate slowed to 3.27% y/y against 3.42% in May and 3.93% in December.

Speaking on Wednesday, Powell, of course, spoke about the Fed's preferred indicator — the Personal Consumption Expenditures (PCE) index. In previous months, the PCE deflator showed a downward trend following consumer prices. It fell to 2.56 y/y in May (compared to 2.68% in April), the core index — to 2.57% y/y against 2.78% a month earlier. This is a positive story for the Fed.

The next Fed meeting will be held on July 31. Whether it will respond to the slowdown in inflation by raising the rate is unknown, but most likely not. In their usual manner, policymakers will pay attention to statistics over a longer period to confirm the need for action.

The second question: does today's report increase the likelihood that the Fed will cut the rate in September? Yes, definitely.

And the third, more practical question: how might the yield on 10-year Treasury bonds change? It's harder to answer here. Perhaps, succumbing to euphoria, investors will momentarily drive bond yields below 4%. But, perhaps, having been burned more than once, market participants will act more cautiously. After all, besides them, there is also a super player on the market — the Treasury. And we know that by the end of the 2024 fiscal year (i.e., by the end of September), the budget deficit may expand from 6.1% of GDP to 7.0%, according to Congressional Budget Office forecasts. Thus, in the remaining months, the Treasury may need to borrow more on the debt market. But we will find out about this at the end of July when the placement plan is published.