November Core Inflation And Impact On Fed Guidance, Yield Curve

The Fed is being pushed in the dovish direction by markets as the stock market is falling and the yield curve is flattening. The problem is the latest inflation reports, which we will review in this article, may encourage the Fed to keep hiking rates because core inflation is stubbornly strong. Some inexperienced traders question why the Fed always inverts the yield curve at the end of the business cycle.

The Fed hikes rates to combat higher end of cycle inflation which slows the economic expansion. The decline in oil prices pushed headline inflation lower, but the Fed sets policy mainly based on core inflation, which excludes oil, so this won’t affect policy. To be clear, it helps workers because their real wage growth is stronger when headline inflation falls. However, with continued rate hikes, the labor market cycle will eventually turn in a negative direction. The yield curve suggests the chance of a recession is increasing.

Strong Core PPI-FD

We introduced the classic predicament the Fed faces at the end of all cycles. Now let’s fill in the details by discussing the November PPI and CPI reports. Headline PPI was 0.1% month over month and 2.5% year over year. Monthly inflation beat estimates for no change and yearly inflation fell from 2.9% in October. Oil prices fell 22% which put headline inflation in the unusual situation of being below core inflation. Without food and energy, monthly inflation was 0.3% and yearly inflation increased from 2.6% to 2.7%. Energy prices fell 5% monthly and rose 2.9% yearly. Food prices were up 1.3% monthly and up 0.4% yearly.

Core inflation, which also excludes transportation, was up 0.3% monthly and stable at a 2.8% increase yearly. Trade services and overall services were up 0.3% monthly and trade services were up 2.2% yearly. The Fed will interpret this report as support for the argument that it needs to keep hiking rates because core inflation is strong.

Core CPI Accelerates

The November CPI report was similar to the PPI report. Headline month over month inflation met estimates for no change. Yearly headline inflation fell from 2.5% to 2.2% because of the decline in oil prices. Energy prices and gas prices were down 2.2% and 4.2% monthly. As you can see from the chart below, core inflation contributed a high percentage of headline CPI.

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