Has the Worst Inflation Passed in the US?... Fed Takes a Breather, High Interest Rates Likely to Continue

[Image source=Reuters Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina] As the worst phase of soaring inflation in the United States throughout this year appears to have passed, the central bank, the Federal Reserve (Fed), has also been able to catch its breath. The Fed’s rationale for slowing the pace of tightening, which may begin as early as this month, has been strengthened, and it is evaluated that the Fed now has more room to maneuver in monetary policy operations next year. However, since inflation still far exceeds the target level for price stability, maintaining high interest rates for the time being seems inevitable.

On the 13th (local time), the U.S. Consumer Price Index (CPI) inflation rate was announced at 7.1% year-on-year, below the market expectation of 7.3%. This is the smallest monthly increase since December last year. Following October’s inflation rate showing the smallest increase this year, November rose by an even smaller margin, indicating that U.S. inflation has passed its peak and is slowing down. The November CPI also rose by only 0.1% month-on-month, below the market forecast of 0.3%. The core CPI, which excludes the volatile energy and food sectors, also rose less than expected (6.0% year-on-year, 0.2% month-on-month). Omar Sharif, founder of Inflation Insights, described the report as "showing a fairly broad-based slowdown."

The CPI was released amid the two-day final Federal Open Market Committee (FOMC) regular meeting of the year. The signal that the pace of price increases is beginning to slow has strengthened the case for the Fed’s previously announced interest rate pace moderation. Currently, the market expects the Fed to take a ‘big step’ by raising the benchmark interest rate by 0.5 percentage points on the 14th, while also beginning to slow the pace of tightening. According to the Chicago Mercantile Exchange (CME) FedWatch, the federal funds (FF) futures market currently reflects more than a 79% probability of a 0.5 percentage point increase. In this case, the U.S. benchmark interest rate would be 4.25?4.50%.

The key now is the Fed’s next move. Following the December big step, there is speculation that the Fed may narrow its pace further to a baby step (0.25 percentage point increase) at the next FOMC meeting in February next year. The probability of a February baby step following the December big step has risen from the mid-30% range to the mid-50% range after the CPI release. Conversely, the probability of a February big step has dropped by more than 10 percentage points.

Paul Ashworth, Chief North America Economist at Capital Economics, said, "While the October CPI, which was below expectations, could be dismissed as a one-off data point, the additional slowdown in the November CPI makes it difficult to ignore this trend." Peter Cardillo, Chief Economist at Spartan Capital Securities, analyzed, "Inflation is on a downward trend," and "the Fed will act less aggressively."

Within the Fed, which has pursued high-intensity tightening throughout this year, a debate between hawks (favoring monetary tightening) and doves (favoring monetary easing) has recently emerged regarding next year’s monetary policy. This is due to growing concerns that unnecessary recession could be triggered. In this context, the CPI released today could act as a catalyst for the doves’ voices to grow louder. Aneta Makowska, Senior Economist at investment bank Jefferies, said, "Following today’s CPI announcement, the dovish camp is expected to strongly push for slowing the pace of rate hikes to 0.25 percentage points." The improvement in supply chain disruptions, which had been exerting upward pressure on inflation, also supports the dovish view.

However, even though inflation has passed its worst phase, it still far exceeds the price stability target (2%), so many analyses suggest that a Fed pivot (directional change) will not be easy. Fed Chair Jerome Powell is also expected to draw a line under pivot expectations at the press conference on the 14th, stating, "The fight against inflation is not over yet," and "Rate cuts are not under consideration." Meanwhile, Wall Street expects the Fed to raise the terminal rate to around 5% through the dot plot to be released the next day. This is in line with Powell’s earlier indication that instead of slowing the pace of tightening, the Fed could maintain higher interest rates for a longer period.

Meanwhile, the market cheered the inflation figures that fell below expectations. On the same day, the Nasdaq index, which is sensitive to interest rates and centered on technology stocks, closed up 1.01% compared to the previous session on the New York Stock Exchange. Meanwhile, Treasury yields fell across the board. The inversion of the yield curve, where the long-term 10-year bond yield falls below the short-term 2-year and 3-month bond yields, continues. This is generally interpreted as a precursor to a recession.

This content was produced with the assistance of AI translation services.