As of Wednesday, the Federal Open Market Committee (FOMC) continues to grapple with the persistent inflationary pressures in the economy, indicating that further interest rate hikes may still be on the table. This comes despite the market-implied probability of another rate increase at next week's FOMC meeting slipping from 8% to 3%, according to data from the CME FedWatch Tool.
The headline 12-month inflation rate rose to 3.7% in August from 3.2% in July, as per the latest Consumer Price Index report. However, core inflation, which strips out volatile food and energy prices, saw an expected decline from 4.7% to 4.3%.
In his August 25 speech at Jackson Hole, Fed Chair Jerome H. Powell reiterated the central bank's commitment to bringing inflation down to its 2% target. He emphasized that the focus is not merely on inflation but also on inflationary pressures, a message that seems to have been overlooked by some investors.
One of the key indicators of these pressures is the labor market imbalance between supply and demand for workers. The Wage Growth Tracker published by the Federal Reserve Bank of Atlanta shows median wage growth averaged 5.3% during June-August, despite a decrease from 6.7% a year earlier, indicating significant upward pressure on overall inflation.
Another factor contributing to ongoing inflationary pressures is consumer expectations. Although median year-ahead expected inflation has dropped significantly from its peak of 6.8% over a year ago, it remains at an elevated level of 3.6%, posing a risk of pushing actual inflation up.
The retail inventory-to-sales ratio also reflects an imbalance between aggregate demand and supply in the economy. The ratio, which indicates whether supplies are keeping pace with demand, remains 19 percentage points below its long-term median. This imbalance is significantly worse than its pre-pandemic record of -15 back in 2012.
Additionally, inflation dispersion or the breadth of inflation is being closely watched by the Fed. This measure reflects the proportion of goods for which prices are increasing or the proportion of total spending that is on goods for which prices are increasing. Although the fraction-of-items measure has fallen to its long-term median, the fraction-of-spending measure remains above its long-term median, largely due to high measured inflation for housing.
Chair Powell has indicated that the FOMC is prepared to raise rates further if necessary and intends to hold policy at a restrictive level until it is confident that inflation is moving sustainably down towards its objective. This stance underscores the fact that despite some positive signs, it's too soon to stop raising rates given the ongoing inflationary pressures.
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