The Fed's Bad Luck Continues

by Michael London | 10/28/2022 8:56 AM
The Fed's Bad Luck Continues

The preferred inflation measure used by the Federal Reserve revealed that price hikes remained rapid in September, and a carefully watched indicator of pay growth is showing rapid growth as well.


On Friday, Federal Reserve officials received news about the economy that was expected but discouraging. Their preferred measure of inflation continued to climb rapidly, and an estimate of wages and benefits that officials closely track continued to pick up quickly. Both of these trends were discouraging.

This year, policymakers have aggressively increased interest rates to cool down consumer demand and the wider economy. They are betting that by doing so, they would be able to slow price increases at a time when inflation is hovering around its strongest pace in over four decades.

They are just observing a small amount of development thus far. The price index for personal consumption expenditures rose by 6.2 percent from the previous year through September, which is consistent with the rise seen in the previous month. Costs have climbed by 5.1 percent over the previous year, a more rapid growth than the 4.9 percent increase seen in the year up until August. This is because food and fuel prices are subject to monthly fluctuations.

Both of these measures of inflation are rising at a rate that is higher than the rate of 2 percent that the Fed targets for inflation on average and over time.


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Central bankers are keeping a close eye out for any indication that the labor market may be beginning to loosen up and that strong wage growth may be beginning to moderate as they attempt to forecast when inflation may begin to slow down. When considering recent pay increases, it is unlikely that inflation will pick up its pace again any time soon. Companies that are confronted with substantial increases in their labor expenses will typically attempt to pass at least some of those cost increases on to their customers.

The Employment Cost Index, a quarterly inflation measure that tracks changes in wages and benefits, increased by 1.2 percent between the months of July and September compared to the previous three-month period. This increase was due to the fact that wages and benefits increased during this time period. This corresponds to the growth of 1.2 percent that was anticipated by economists in a study conducted by Bloomberg. The prior report indicated that there was a gain of 1.3% in the index.

This index gain translates to 5.0 percent on an annual basis, which is down just slightly from 5.1 percent in the previous report but is still an exceptionally quick rate of increase. Despite this small decrease, this rate of increase is still an unusually quick rate of increase. This figure increased at a rate of 2.2 percent annually in the decade leading up to the pandemic, which highlights how quickly progress is being made.

The Federal Reserve will hold a meeting the next week, and practically everyone anticipates that on Wednesday, they will announce an increase in interest rates of three-quarters of a percentage point. Officials have previously indicated in economic forecasts that they expected to slow to a half-point rate increase in December, and investors will closely watch Fed Chair Jerome H. Powell's post-meeting news conference for any sign that such a step down is imminent. In addition, officials have previously indicated that they expected to slow to a quarter-point rate increase in January.

Officials have made it plain that they intend to cease rising interest rates at some point in the future but that, at that point, they intend to keep them at a high level for a period of time. It is anticipated that this will continue to act as a drag on economic development, bringing about a deceleration of economic activity, a reduction in inflation, and, most importantly, the avoidance of a severe economic downturn.

The inflation numbers that will be released on Friday are not likely to significantly alter the opinions of the central bank. When it was published in the middle of October, the related but more timely Consumer Price Index showed a sharp spike in September. As a result, the officials already knew that inflation had continued to run quickly during the previous month.

However, the newly collected statistics on wages for the third quarter might sway the thinking of policymakers, at least a little bit. Fed officials pay special attention to the Employment Cost Index because it avoids some data issues plaguing other wage metrics, including monthly average hourly earnings estimates. These data have a tendency to fluctuate as a result of changes in the composition of the labor force. For instance, if a large number of workers receiving low wages quit their jobs, the hourly earnings metric may suddenly increase. This is one of the reasons why the Employment Cost Index is so important.

The data from the Employment Cost Index for the third quarter of the prior year, which came in very strong, was particularly noted by Fed officials as a primary reason for moving their attitude toward more rapidly withdrawing support from the economy.

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                 We're finally seeing the lagged effect of the Fed's policy tightening on the economy

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