A strong US economy adds 'downside risks’ to inflation

The 2023 economic story centers on slowing inflation, with stronger-than-expected economic growth as the US heads into recession. This is despite the economy navigating a high interest rate environment for more than two decades.

But as we approach 2024, stronger-than-expected consumer inflation could prevent more good news on the inflation front and affect how Federal Reserve Chairman Jerome Powell frames the central bank’s fight against inflation during his speech in Jackson Hole, Wyo., on Friday.

„We think Powell’s tone at Jackson Hole will be less dovish than the July FOMC minutes, as recent data raises the risk of a fresh rise in inflation,” Bank of America and global economist Shruti Mishra wrote in a note on Sunday.

Federal Reserve Chairman Jerome Powell at the Dirksen Building on June 22, 2023. (Getty Images via Tom Williams/CQ-Roll Call, Inc)

Powell’s speech comes after another strong run of economic data that showed consumer spending was resilient in July. Economic growth in the third quarter is now on track for its fastest pace since the fourth quarter of 2021.

„As commodity prices rise, inventories peak, and inflationary forces from adjusting supply chains end, as demand picks up again, we see upside risks to commodity prices.” Citi economist Veronica Clarke wrote in a note on Monday.

A 0.7% rise in retail sales in July – a 10.3% improvement in non-store retail sales compared to last year – showed consumers were still spending on goods. The strength in commodity consumption, Citi’s economists argue, could introduce a greater chance of inflation re-accelerating.

Beneath the headline decline in inflation over the past several months is a more complex narrative brewing.

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Headline inflation as measured by the Consumer Price Index (CPI) rose 0.2% in July. The same can be said for „core PCE” excluding volatile food and energy categories.

Economists overwhelmingly believe that this is positive for the central bank as the core CPI has increased at a slower pace after October 2021.

But Jefferies US economist Thomas Simons argues that this may not show the full picture.

According to Simons, healthcare services and airfares have also proven to be highly volatile in the post-pandemic economy. Stripping out those measures, Simons’ alternative measure of „super duper core services inflation” rose 0.7% in June, the biggest monthly increase since February.

Super duper Core Services Inflation rose 0.7% in July, the most since February.

Super duper core service inflation rose 0.7% in July, the most since February.

„The Fed can breathe a little and celebrate the strong inflation trend from last summer,” Simons wrote in an Aug. 11 note to clients.

„However, it’s still very early in the victory lap, and this pressure on the super-duper core measure of inflation will encourage the Fed to keep rates high and provide poor policy guidance.”

EY-Parthenon Chief Economist Gregory Daco recently pointed out in a Yahoo Finance chartbook that if the stickiness like Simons highlights goes away and monthly inflation picks up again, inflation could end 2023 higher than it is today.

„The 'free inflation lunch’ is now over from rapidly falling energy prices, cooling food price inflation and easing core commodity inflation, and additional inflationary momentum should come from slower month-on-month gains in the cost of core services,” Dako said. .

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The labor market is booming

Although the pandemic-era job market is no longer booming, Americans are still seeing significant wage gains.

Wages are growing at a 4.4% pace from a year ago Inflation figure is 3%That means „real” wages, or those adjusted for inflation, are now positive for the first time since March 2021.

New data from New York Fed survey Published on Monday The average wage earner is now willing to leave a job for $78,645, an all-time high and up 8% from last year.

For Simons’ part, stubborn wage growth means „we doubt we’ll see much relief.” [super duper core services inflation] Prices will continue to rise until there is more slack in the labor market, which won’t happen anytime soon, Simons wrote.

„Wages higher than inflation mean real wages are positive again,” Powell said Press conference on July 26. „It’s a big thing. Of course, we want that. We want people to have real wages, but we want wages to rise over time in line with 2 percent inflation … but wages are probably the key issue, going forward.”

Elsewhere during his press conference, Powell reiterated his view that the labor market is „very tight,” although some signs of „better balance” are emerging in the U.S. labor market.

„Labor market conditions will be an important part of the return to inflation, which is why we think there needs to be a little more easing in labor market conditions,” Powell said.

Josh Shaffer is a reporter for Yahoo Finance.

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