The Federal Reserve has announced its first rate pause since it began to raise short term rates last year. But it threatened to raise rates twice more this year after a six week pause to study the impact of its policies to date.
Inflation may have all but disappeared by then, at least for wholesale goods and services that took a sudden plunge in May.
The Producer Price Index (PPI), the Federal Government’s wholesale inflation indicator, shows the Federal Reserve has already overreacted to the inflation surge. Its index for final demand plunged from 2.3 percent to 1.2 percent YoY in just one month, April to May 2023.
“In May, the decline in the final demand index can be traced to prices for final demand goods, which fell 1.6 percent. The index for final demand services increased 0.2 percent,” said the BLS. “Prices for final demand less foods, energy, and trade services were unchanged in May after inching up 0.1 percent in April.”
These changes will also be reflected in the retail Consumer Price Index in coming months, and we could begin to experience a close to zero overall inflation rate if it continues its downward trend very soon.
Another inflation indicator is moving quickly downward, U.S. import prices, which fell 4.6 percent from March 2022 to March 2023. This was their largest over-the-year drop since import prices declined 6.3 percent from May 2019 to May 2020.
All signs are now pointing to lessening demand from consumers and businesses. So, do consumers and businesses want to live in a zero-inflation rate environment if the Fed keeps raising interest rates?
No, is the short answer because when prices stop rising they quickly begin to fall in such a consumer-oriented economy as ours. That's good, isn’t it? But not too much because it’s a sign of falling demand for products, and less demand means businesses see shrinking markets and soon begin to cut jobs.
This hasn’t happened yet but we have a good example in the last decade as it recovered from the Great Recession. PPI for Final Demand was at zero inflation from January 2015 to August 2016 YoY, and quarterly GDP growth was less than 1 percent during the period, per the St. Louis FRED.
It looks like Ian Shepherdson’s remarks are coming true that I quoted recently.
“The forces that drove up inflation since the onset of the Covid pandemic are reversing rapidly,” said Ian Shepherdson, chief economist at Pantheon Economics, in a recent Barron’s article. “Over the next year, both the headline and core rates—the latter excludes food and energy prices—will drop sharply. By the end of 2024, inflation is likely to be below the Federal Reserve’s 2% target, and policy makers will be trying to stop it falling too far.”
The irony is that Fed Chair Powell has said they may have to continue to raise rates even if it causes job losses, if they are to meet their 2 percent inflation target.
He just said inflation has not moved down as much as they would like at his latest press conference. What would it take to convince him and the Fed Governors otherwise, another recession?
Harlan Green © 2023
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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