What's Next for Sidelined Money After CPI Pushes Clear Fed Decision
The latest economic data underscored an interest rate reality for the Federal Reserve and here's where money is likely to flow.
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On Thursday morning, the Bureau of Labor Statistics released its report on consumer level inflation, known commonly as the CPI or Consumer Price Index, for the month of August.
Hopes were high for a cooler report after Wednesday's release for producer level prices, or PPI, had not only been ice cold but outright deflationary on a month-over-month basis. Remember, producer prices can be considered, though it does not always work out so perfectly, as a leading indicator for consumer prices. So, in reality, those high hopes were somewhat unrealistic as producer prices had been red hot, no, make that white hot, in July.
Let's take a look at the numbers.
At the headline, August CPI accelerated on a month-over-month basis from 0.2% growth in July to 0.4% growth in August. Growth of 0.3% had been expected. On a year-over-year basis, headline CPI increased 2.9% as expected and up from 2.7% growth in July. So, at the headline, there was increased inflation from July, but no more than was expected, at least on the more closely watched (by the Federal Reserve anyway) annual number.
At the Core, (ex-food and energy), CPI grew 0.3% month over month in August, in line with the pace of July and as expected. Core CPI, on a year-over-year basis, printed at growth of 3.1%, also in line with July and also as expected. Core CPI did not "pop," despite that heated July print for Core PPI. That's encouraging if you're a voting member of the FOMC.
The Good News...
...Is that August PPI retraced July PPI to some degree and sort of "normalized" July and August when looked at as a two-month period.
What Was Hot?
For the month of August, consumers had to dig deeper to pay for groceries, tobacco products, gasoline, used vehicles, motor vehicle repair and transportation services. Within groceries, prices for fruits and vegetables were red hot. Within transportation services, airfare "soared" (get it?) into the stratosphere. Shelter, which is always a big deal, was up 0.4%, in line with the headline print.
What Was Cold?
During August, consumers caught a break when purchasing piped gas, electricity, medical care commodities and medical care services. Within other categories, dairy products did not rise in price with other groceries, fuel oil prices did not rise with gasoline, and if you can believe it, automobile insurance prices did not rise for the month.
More Worrisome
Perhaps the more cage-rattling macroeconomic data point released on Thursday morning had nothing to do with inflation at all.
The Department of Labor, which compiles data on unemployment filings from the states, reported 263,000 initial jobless claims in its weekly report. This was well above the 235,000 filings that economists were looking for and, on top of that, the worst week for this print since late October 2021.
This underscores the now worrisome weakening of the demand side of U.S. labor markets. Thanks to some extremely inaccurate and sloppy work at the Bureau of Labor Statistics, we are only now learning, statistically (we knew anecdotally) of this softening that dates back to at least April 2024.
On Policy...
The less-than-terrifying data on inflation coupled with the increasingly scary numbers on labor make the Federal Reserve's job easier. Accomplishing favorable results might not be easy, but the choice that must be made at the fork in the road is clear. The Federal Reserve has been charged by the U.S. government with a dual mandate.
The central bank must try to achieve price stability while also working toward full employment. Unfortunately, these two mandates often work against each other and force decision makers to balance one against the other or "rob Peter to pay Paul."
Until now, Fed Chair Jerome Powell chose to focus on fighting inflation because, according to the data provided, the employment situation was quite healthy. Now, quite suddenly as there has been a change in leadership at the BLS and the agency is trying to clean up its act, data-dependency, which had supported Powell's inaction, now demands an aggressively dovish pivot.
Fed Funds Futures
Fed funds futures trading in Chicago have been moving around, so I checked them ahead of Thursday morning's data dump and then waited a couple of hours to record another look. These markets are pricing in a 100% probability for a 25-basis point rate cut on September 17 (which is next Wednesday), same as Thursday morning. There is actually an 11% chance priced in that the Fed starts its easing cycle off with a 50 basis point rate cut next week. That's up from 8% shortly before.
According to these markets, there is now a 93% likelihood for a second 25 basis point rate cut on October 29 (up from 79%) and an 87% probability for a third 25 basis point rate cut on December 10 (up from 70%). There is now, according to these markets, a 64% chance for an additional 7 basis points worth of rate cuts in calendar year 2026, up from 57% on Thursday morning.
Investing?
Well, this is an art and not a science. What we think we know is this: Easing monetary policy will weaken the U.S. dollar, which creates an upside risk to inflation. On the other hand, if the nation is in recession or getting closer to one, higher unemployment is deflationary as is increased productivity. The advent of generative artificial intelligence will put downward pressure on both demand for labor and wages, while greatly enhancing productivity on a per-laborer basis.
We think we know that lower interest rates will force some of that cash that has been on the sidelines to move out of T-bills and either out toward longer duration, lower quality, precious metals and/or equities. Those moving into equities will favor growth industries such as high-tech and communication services over high-dividend paying industries such as the utilities.
The financials could run into some trouble as well as changed policy pressures net interest margin and more difficult economic conditions create increased business and household credit risk.
At the time of publication, Guilfoyle had no positions in any securities mentioned.
