U.S. inflation fell in November for the first time in more than 2.5 years, a highly promising sign that the Federal Reserve’s aggressive interest rate hikes are beginning to achieve their intended effect of taming high prices across the economy.
Key Inflation Gauge Undershoots Expectations
The Personal Consumption Expenditures (PCE) price index, which measures costs paid by consumers and is the Fed’s preferred inflation gauge, declined 0.1% in November from the previous month, the Commerce Department reported Friday.
Core PCE inflation, which excludes volatile food and energy costs, rose just 0.2% – less than the 0.3% advance economists had forecast. On an annual basis, core PCE inflation slowed to 4.7% in November from 5.0% in October, moving closer to the Fed’s 2% target.
“This morning’s inflation data are welcome news and show meaningful progress in the fight against higher prices,” said President Biden in a statement. “Inflation is coming down in America month after month, giving families some breathing room.”
| Month | Core PCE Inflation (YoY) |
|---|---|
| November 2022 | 4.7% |
| October 2022 | 5.0% |
| September 2022 | 5.2% |
The better-than-expected inflation figures battered Treasury yields and lifted stocks, signalling growing conviction in financial markets that the Fed can engineer an economic “soft landing” where growth cools enough to tame inflation without causing a severe recession.
Rate Cut Hopes Accelerate
Bets are now rising that the U.S. central bank could slow its interest rate hiking campaign as soon as March and potentially begin cutting rates before year-end to boost growth as inflation pressures continue easing.
“Inflation is heading in the right direction, and the markets are now expecting the Fed to cut rates in the back half of the year if economic growth slows as expected,” said Ryan Sweet, chief U.S. economist at Oxford Economics.
To combat the hottest inflation in four decades, the Fed has raised its benchmark interest rate target from near zero in March to a range between 4.25% and 4.50% currently. Another half percentage point rate hike is expected at the Fed’s next policy meeting in February.
Further Cooling Anticipated
Most economists expect inflation will moderate further in the coming months amid improving supply chains, cooling demand and favorable year-over-year comparisons.
“Assuming oil prices remain constant at current levels, headline and core inflation will drop noticeably again in December,” said Bill Adams, chief economist for Comerica Bank.
Lower inflation paves the way for Fed officials to dial back interest rates in the second half of 2023 to spur economic activity without overheating prices. More dovish Fed policy would be welcomed by equity investors but prove negative for the U.S. dollar and bond yields.
“As inflation continues to ease, markets will become more confident that the Fed is approaching the end of this rate hike cycle,” said Nationwide chief economist David Berson. “This will put downward pressure on intermediate- and long-term interest rates.”
Consumers Begin To Splurge Again
In another encouraging sign that inflation may be on a sustainable downward trajectory, the Commerce Department report showed consumer spending rose 0.5% in November – a relatively strong gain that hints high prices have not crimped Americans’ ability to spend.
Consumer spending accounts for about 70% of all economic activity in the U.S. The solid November increase follows a 0.9% jump in October and indicates consumers still have healthy savings and buying power despite elevated inflation.
The combination of slowing inflation and resilient consumer demand boosts hopes that the economy can avoid a severe downturn even as higher borrowing costs lean against growth. JP Morgan economists now see a “vibecession” where growth slows but the economy avoids plunging into recession.
Fed Not Ready To Declare Victory
While the inflation data points to easing price pressures, Fed Chair Jerome Powell has repeatedly stated the central bank needs to see a consistent pattern of months of moderating inflation before it lets up on rate hikes.
“The disinflationary process has started in the U.S., but Powell knows that it still has a long way to go before inflation gets back to target on a sustained basis,” said Paul Ashworth, chief North America economist at Capital Economics.
Powell has singled out the exceptionally tight job market – with unemployment at a five-decade low near 3.7% – as a factor keeping upward pressure on wages and prices. Pay growth for American workers is running about 5% on an annual basis, well above the pace consistent with the Fed’s 2% inflation target.
Still, the peak for Fed rate hikes is now clearly in sight. Economists believe Fed officials will slow the pace of rate increases starting early next year, halting around 5% by mid-2023. Rate cuts could then arrive in the second half of 2023 if inflation shows further progress toward the central bank’s goal.
“We expect inflation will continue to slow in the months ahead, and that creates the possibility for the Fed to dial back rate hikes starting in March, and maybe even cut rates before the end of the year,” said Nationwide’s Berson.
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