Inflation Takes a Chill Pill

Michael Normyle – Nasdaq’s US Economist joins IBKR’s Jeff Praissman to discuss the slowing down of inflation the US is experiencing.

Summary – IBKR Podcasts Ep. 120

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

 

Jeff Praissman 

Hi everyone. Welcome to IBKR podcast. I’m your host, Jeff Praissman, and it’s my pleasure to welcome back to the IBKR podcast studio, Michael Normyle, Nasdaq’s US economist. Welcome Michael, how are you doing? 

Michael Normyle 

Doing well, thanks. Thanks for having me back. 

Jeff Praissman 

It’s always a pleasure to have you in the studio. Today we’re going to discuss the cooling inflation that we’re seeing right now. So I’d kind of like to start off with- where is core inflation now compared to where it was in the first half of the year? 

Michael Normyle 

Sure. So, yeah, I’m going to focus on CPI data here since we have one more month of CPI than we do for PCE data. So core CPI inflation is down to 4% year over year as of October. In the first half of the year, it was mostly hovering around 5.5% in year over year terms and it only really started to fall. By June, it was kind of flat. More or less flat for much of the first half.  

But we’ve really seen a broad-based decline since then and there’s kind of three big buckets of core inflation- that’s housing, core services excluding housing, and then core goods. And so we’re seeing housing inflation slow from over 7% year over year to 6.7%. And shelter has a big weight, it’s about a third of overall inflation, not core inflation, but overall. And the rest of core services has slowed from over 5% to below 4%. And that’s mostly wage driven. And then of course core goods inflation has fallen from about 2% to 0%. 

Jeff Praissman 

We’re talking about CPI data, but food and energy aren’t included in the CPI, correct? 

Michael Normyle 

Well, right, so they’re not included in the core CPI. Headline CPI of course does include food and energy, but since they are, you know, more volatile, they can move a lot. And since they’ve got a pretty big weight, they’re about 20% combined of overall CPI. So since the Fed looks at core, they look at that. Since it excludes those more volatile components, it gives you a better idea of where inflation is kind of headed. So of course, you know our lived experience, right, everyone, you still have to pay for energy. You still have to buy food. But of course, core CPI excludes it, but that’s more just for signaling where inflation is headed. It gives a clearer message. So food inflation has been slowing. It’s gone from over 10% year over year growth for much of. last year to just 3% now- 3.3%. It’s been driven by both sides of food inflation, so food you can kind of split it into food at home, which is groceries and food away from home, which is restaurants. And so a big driver of this slowing in food inflation has been wage growth. Because wage growth is even a big component of grocery store prices, not just restaurant prices. And then what we’ve seen with energy is even more extreme. Energy inflation was as high as 42% year over year last year, but for the last eight months, energy has seen negative year over year growth.  

And of course a lot of that has to do with base effects where we’re comparing recent months to a year ago when energy prices were much higher because of the war in Ukraine having started relatively recently a year earlier. And that resulted in concerns about energy supply pushing up energy prices really quickly. But over the last year plus energy supply lines have been redrawn and we’ve seen some cooling in demand too. Both of which have helped bring down energy prices quite quickly. 

Jeff Praissman 

And historically once inflation starts slowing down, does it tend to stay that way for a while or do you think this is just maybe a slight pause and we could just see rising prices again within the next few months, maybe once we get past the holiday cycle? 

Michael Normyle 

So inflation does have a strong cyclical element to it. So it’s often either ramping up or ramping down. It doesn’t tend to stay in a tight range, just kind of moving sideways for too long. But we’re already pretty far into this cycle, and inflation has been slowing since June of last year. That’s when the peak was. So it’s been 16 months of slowing at this point in this cycle. Still, I think there is more to go because if you look at market-based measures of rents and home prices, those tend to lead shelter inflation and those market-based measures have been in a downturn for a year and a half already, so we’ve still got that market-based shelter disinflation in the pipeline. And since shelter is 1/3 of the weight of CPI, we could easily see inflation slowing well into next year. 

Jeff Praissman 

And how have the stock and bond markets been reacting to this slowdown over the past, let’s just say recent couple months or so? 

Michael Normyle 

Well, yeah, it really depends on the month, because every inflation print has been seen through the lens of what it means for the Fed. And so, if the print has been higher than expected, that means the Fed’s going to hike more so markets sell off. If the print is lower than expected, then we see the opposite. And so, this latest print for CPI was below expectations. So we saw stocks jump- that Nasdaq 100 was up about 2% that day and bond yields dropped. And so, if you look at inflation cycles historically, there’s always some noise, though during upswings and downswings. It’s never, you know, straight line up or straight line down. So it’s entirely possible that that we see another upward surprise in inflation in the next few months, even if it turns out to be more noise than signal. So markets have been really, really focused on each individual month. And so that kind of the trend in a lot of ways. But I think you know you just need to be prepared that that it can be noise more than signal sometimes. 

Jeff Praissman 

Do you think the Fed will continue to raise rates or do you think they’ll lower them or just keep them steady as they are right now within the next cycle or two just short term I guess? 

Michael Normyle 

Yeah. I think for months now, there’s been so many signs that inflation is coming down and so many of those signs should have been just hard for the Fed to justify hiking rates. And thankfully, they have mostly held off. So in the last six months, we’ve just had one 25 basis point rate hike back in July. So I think there are not any more rate hikes coming. But we might still be a ways away from cuts. The Fed’s been clear about wanting to keep rates higher for longer, and thinking that that’s necessary. So that’s why we might not see the first hike until around the middle of next year, or I’m sorry, first cut until the middle of next year. So you know that that would mean that they’ve kept rates at the the peak of 5.25 to 5.5% range for roughly a year, which, you know, maybe would be enough for them to say, hey, we did hire for longer. So now we can start cutting rates. 

Jeff Praissman 

Are there risks to lowering the rates? If and when they start to lower them, is it possible to go too quickly or too far the wrong way? Could we end up in a recession or even a depression from that? Is that some of the effects that could happen? 

Michael Normyle 

I think the risks are going to be pretty minor. For one, I think the Fed will be pretty deliberate and cutting rates, so it’s going to be a slow process. Barring recession, in which case you know they would have to cut rates pretty quickly. The issue with monetary policy having long and variable lags, that cuts both ways. So cutting rates will have an immediate impact on market sentiments. But the transmission to much of the real economy will be slow. And going too far too quickly in terms of cuts. I really think the risk there would be more over stimulating the economy. And seeing inflation come back kind of fast and furious, but really not a risk of recession or depression. 

Jeff Praissman 

You talked about wage growth in the beginning of this podcast. And sort of on a on a different line of that though, does the cooling economy have any effect on unemployment rates? 

Michael Normyle 

Yeah, there’s definitely a delicate balance that the Fed has to strike with slowing down the economy because the real risk is that we see kind of negative feedback loops which can tip the economy into recession. So, if the economy slows, then consumers might start to get worried about their job security. So then they decide to spend less and then that reduces business revenues. And so then businesses have to cut costs via layoffs. And so that reduces spending further and so on and so forth. So you can have these kind of vicious cycles develop. But I think it’s important to recognize too, that the economy, it’s often picking up. Or slowing down and those slowdowns don’t often end in recession. 

Jeff Praissman 

Well, Michael, this has been great. You know, before we sign off, is there any final thought to leave our listeners with regarding the economy, either the cooling of the economy or just the economy in general? 

Michael Normyle 

Well, I think one last point on inflation is just to.. I know it’s been a long process, but I think we’ve made a lot of progress on bringing inflation down. So I mean, I say we, like I’ve done anything but you know the Fed and the economy in general. But in June of last year we had inflation at 9% and now it’s 3%. And of course, you know, going forward, progress getting back down to that 2% target is probably going to be a bit slower. But you know, with wage growth slowing while still relatively high and more shelter disinflation in the pipeline, I’m pretty confident that we can get close to that 2% target probably faster than the Fed thinks. 

Jeff Praissman 

Well, Michael once again, I want to thank you for coming by and joining us at the IBKR podcast studio. For more from Michael and Nasdaq, please go to our website under education to view previous Nasdaq webinars as well as our previous podcast with Michael. Thank you again for listening until next time. I’m Jeff Praissman with Interactive Brokers. 

Contact Information:

michael.normyle@nasdaq.com