It is no secret that the Federal Reserve is determined to get inflation back to its 2% target rate after surging to a 40-year high in 2022. To combat rising prices, Fed officials have hiked interest rates over the past 15 months at the fastest pace in history. With Core Consumer Price Index (CPI) inflation still more than double the central bank’s inflation target, it’s likely that further rate hikes lie ahead. Although recent improvement in the overall inflation data has eased some of the pressure on the Fed, their most recent expectation is for two more quarter-point hikes this year.
The most obvious evidence that inflation pressures are decreasing is a decline in the Headline Consumer Price Index. Headline CPI decreased from 4.0% to 3.0% on a year-over-year basis in June, with many optimistic declarations on Wall Street. If you exclude the extremely lagging shelter component, CPI inflation dropped to less than 1.0% in June – though housing plays a very significant role in the U.S. economy. While it’s clear that inflation is falling, the employment side of the Fed’s dual mandate is not letting them off the hook quite yet…
Despite inflation data giving Fed officials some slack in recent months, official employment figures remain historically strong, indicating that further monetary tightening may be necessary. Most notably, the Unemployment Rate remains at just 3.6% – one of its lowest readings of the past 50 years. Additionally, Non-Farm Payrolls grew by +209K last month. While this employment data is notoriously lagging, and often heavily revised, these indicators hold the most weight in the minds of Fed officials when making policy decisions.
While inflation pressures have continued to ease this year, employment data is not giving the Fed the all-clear to end the current rate hike cycle. As a result, upcoming labor market reports will play a more significant role in the Fed’s policy decisions in the second half of the year. Furthermore, any reinvigoration of headline inflation pressures will be amplified so long as the labor market remains extremely tight.