US Inflation tapers to 7.1%; will the Fed go slow now?

On Tuesday, 13th December, the US Bureau of Labour Statistics (BLS) put out the consumer inflation number. On a sequential basis, the inflation fell 60 bps from 7.7% in October 2022 to 7.1% in November 2022. From the peak of 9.1% in June 2022, consumer inflation in the US has fallen a full 200 bps now. One can argue that Fed rates are up nearly 400 bps and inflation is down by just 200 bps, but there is normally a time lag. In the coming months, the cumulative effective of the rate hikes would be more pronounced on the inflation number. The question is how will this inflation number impact the rate decision by the US Federal Reserve, but we will debate more about that point towards the end.

Even ahead of the inflation announcement, Jerome Powell had already announced that the Fed was likely to slow down on rate hikes. This gave the first indication that rate hikes would be restricted to 50 bps in December, but that would only be known late on 14th December. Between March 2022 and November 2022, the Fed has already raised the rates by a full 375 basis points from the range of 0.00%-0.25% to 3.75%-4.00%. Of these, the last 4 rate hikes have been worth 75 bps each. With the rates already a full 125 bps above the neutral rate, the impact on inflation is likely to get a lot more pronounced in the coming months.

US inflation is down across categories

The table below captures the gist of long term inflation and high frequency inflation in the last 2 months.

Chart Source: US Bureau of Labour Statistics

The overall inflation is broken up into 3 components viz. food inflation, energy inflation and core inflation (residual inflation). In November 2022, there has been a perceptible drop in food inflation and energy inflation. Even though core inflation has trended lower, it continues to hover around the 6% mark. If you look at the YOY inflation above, it was lower across all the 3 major categories viz. food inflation, energy inflation and core inflation. Food inflation fell 30 bps from 10.9% in October 2022 to 10.6% in November 2022. During the same period, energy inflation fell 450 basis points from 17.6% to 13.1%. Even core inflation fell from 6.3% to 6.0% and is now down 60 bps in the last 2 months.

Are there are specific trends emerging? Food inflation is down on YOY basis, but remains 0.5% higher on sequential basis. Within the food basket, vegetables and fresh fruits saw lower inflation while high protein items like meat and dairy products saw higher inflation. There have clearly been pockets of diverse movements in the food space. Secondly, the fall in energy inflation has been driven by the sharp fall in gasoline prices and natural gas, although fuel is still up. Lastly, core inflation has tapered, but the pressure is still coming from fuel related services like energy services, airline fares and transport related services. However, other items of core inflation has shown a tendency to taper.

Real trend is in the High Frequency inflation

The best way to understand the short term trends in inflation is to look at the MOM inflation, which is why the BLS dwells separately on YOY inflation and also on MOM inflation, which is a proxy for high frequency inflation. Here are the takeaways.

Here is what we read from the MOM inflation data for November 2022.

1. MOM food inflation has spiked by 0.5% with 4 out of 6 heads getting dearer. Fruits, vegetables, cereals and bakery products got dearer while meat and poultry got cheaper.
    

2. The MOM fall in the Energy index by -1.6% shows that even the short term trend is down. Gasoline and natural gas were lower MOM but fuel and electricity spiked.
    

3. November core inflation was up 0.2% MOM with pressure coming from rent and shelter and fuel dependent services, while cost of medical care tapered.

Will the Fed go slow, and what it means for India?

At the outset, the Fed does not make rate decisions based on consumer inflation but based on PCE inflation. However, it is consumer inflation that drives inflation expectations, so it continues to be a key variable. Even before the inflation number was announced, the Fed had already hinted at a 50 bps rate hike in December and it would most likely stick to that. For the Fed, inflation has fallen and growth has turned around in the third quarter. That is good reason to start toning down their accent on inflation control at all costs. To impress the markets the Fed would have to either go for a lower rate hike or cut terminal rates. One thing is clear that rate hikes may slow for now, but they are far from over.

How will the US inflation data impact India? In the December policy, RBI had already tapered rate hikes from 50 bps to 35 bps and it could even take a pause in February 2023. However, there is still no clarity on terminal rates in both the economies. For India, the real rates are finally in positive territory, although the same cannot be said about the US economy. Hence, we could still have the US hiking rates and the RBI going slow. The real story is something bigger. Both, the US and India, are done for now with their single-minded pursuit of inflation control. It looks like the Fed could have a change of hears. RBI can now try and focus on growth apart from inflation alone. That is the good news!