A decline in the price of housing services has been at the center of the long-standing narrative dismissing the significance of this years long stickiness in inflation. Unfortunately, those hopes are less tenable than ever in this cycle. In April, housing experienced its highest month-over-month PCE increase since at least the beginning of 2025. This sticky inflation is unlikely to cool while housing inflation remains elevated.

Thus, the long-awaited rate cuts that new Federal Reserve Chair Kevin Warsh was supposed to deliver for the President seem quite remote. Financial markets do not even have a rate cut among the range of possibilities this year. The CME FedWatch tool shows the odds of a rate cut at less than 1% going all the way out to July, 2027. The odds of a rate HIKE push above 50% starting with the January, 2027 meeting (see the red circle in the upper right corner of the chart below).

Meanwhile, loose financial conditions per the Adjusted National Financial Conditions Index (ANFCI) suggest the case for rate cuts remains quite weak.

Bonds Push Gold to the Sidelines

Typically, this is the point where I celebrate gold as a good buy in the face of increasing inflation risks. However, the bond market woke up to increasing inflation risks after the war started. For example, a day after the iShares 20+ Year Treasury Bond ETF (TLT) broke down from a 4-month high on the first wartime trading day, SPDR Gold Shares (GLD) also broke down.

Both TLT and GLD have been in downtrends ever since the war started (interest rates increase when bond prices decrease). While TLT printed a sharp bottom last week thanks to a sudden drop in oil prices, gold continued to fall.

As long as financial markets expect the Fed’s next move to be a rate hike, I expect GLD to trade poorly. Right now, GLD is precariously perched at an important support formed from the convergence of the 200-day moving average (DMA) (the blue line above) and GLD’s former all-time high from October, 2025. GLD experienced an impressive bounce off the horizontal support line in late March. However, given the definitive failure at resistance at the 50DMA (the red line), I expect the current tepid bounce to give way to continued weakness in GLD.

Thus, I am staying away from buying back into GLD until it can achieve a breakout above 50DMA resistance. In the meantime, I continue to accumulate TLT in anticipation of a day off in the future when yields come down definitively.

Be careful out there!

Full disclosure: long TLT

The post From Sticky to Streaky, Inflation Looms Larger appeared first on Inflation Watch.

Services was the biggest driver of December’s core PCE with a 3.5% year-over-year jump. Services has been a consistent contributor to inflation’s stickiness. The biggest components within services were housing and utilities, recreation services, and financial services and insurance. Each of these components were also top drivers of services PCE inflation a year ago, so I fully expect them to continue to remain elevated…and worrisome.

Why Does the Fed Prefer PCE over CPI?

The general public and financial media pay much more attention to the CPI than the PCE. So it is easy to understand how a hot PCE number got little attention among the tariff headlines. However, the Fed cares more about PCE because it is a more comprehensive measure of inflation than the CPI. The PCE relies on business surveys that include expenditures made on behalf of consumers. In an explainer, the BEA provides the following example:

“For example, the expenditure weights for medical care services in the CPI are derived only from out-of-pocket expenses paid for by consumers. By contrast, medical care services in the PCE index include those services purchased out of pocket by consumers and those services paid for on behalf of consumers—for example, medical care services paid for by employers through employer-provided health insurance, as well as medical care services paid for by governments…”

This distinction is particularly important since the Fed spends a lot more time talking to businesses (like in the Beige Book) than to consumers.

Gold probably got both messages: sticky/heating inflation and fresh economic chaos. The SPDR Gold Shares (GLD) bounced perfectly off support at its 20-day moving average (DMA) (the dashed line) and followed through with a 2.7% gain to start the trading week.

Be careful out there!

Full disclosure: long GLD calendar call spread

The post The Fed’s Favorite Inflation Measure Leapfrogs the CPI appeared first on Inflation Watch.

FXA rode the economic tailwinds to a breakout for a 15-month high.

Data from the Australian Bureau of Statistics (ABS) suggests that the unemployment rate has likely peaked at October’s 4.4% with December’s reading at 4.1%.

Even more important for monetary policy, the consumer price index (CPI) in Australia is above the RBA’s target 2-3% range. After dropping as low as 1.9% last year, the CPI suddenly rebounded above the RBA’s target range. Improving economic numbers will thus threaten to keep inflation higher than target if the RBA does not pivot to a tighter policy stance.

And then there are commodities, the core of Australia’s economy. Companies like iron ore producer Rio Tinto have enjoyed strong rallies to start the year as investors wake up to the economic realities of massive infrastructure and energy investments to support the AI boom along with the increasing attractiveness of physical assets as major countries pile on more and more debt. I started accumulating RIO in October and included the stock on my shopping list for 2026. So far, the price action has yet to deliver any kind of buyable dip. The strength of these commodity plays suggests that commodity-rich economies are going to experience upward pressure on their currencies. The breakout in RIO aligns well with the breakout in the Australian dollar.

Conclusion

All signs point to continued strength in the Australian dollar. A pivot in monetary policy will all but confirm a bias higher for the currency. Moreover, Australia looks relatively more attractive as a country versus major economies like Japan and the U.S. where policy and political turmoil along with mounting debt levels could keep those respective currencies under constant pressure. My main question now is how and when will fresh buying opportunities come.

Be careful out there!

Full disclosure: long FXA

The post Australian Dollar Breaks Out As Economic Winds Blow Toward Rate Hikes appeared first on Inflation Watch.

Still, after the dust settles on this meeting, I fully expect the Fed to stay the course with a rate cut in December. Powell’s statements belie a Fed that is both gradually (some reluctantly?) accepting the case for looking through inflationary pressures and getting incrementally more worried about the labor market.

Division Translates Into Balking

Powell acknowledged strong disagreements among the Committee members. He teased a reveal in the upcoming minutes from the meeting, but the Fed vote says plenty. Recent appointee Stephen Miran unsurprisingly wanted a 50 basis point cut in a repeat of his dissent in the September meeting. Kansas City Fed governor Jeffrey R. Schmid delivered a dissent at the other end with a vote for leaving rates unchanged. Thus, it is easy to imagine the Fed currently holds a broad enough range of opinions on the direction for monetary policy to cause a pause in December.

In response to a reporter’s question about division in the Fed, Powell pointed out that Committee members have different forecasts and different levels of risk tolerances which come through in their speeches. Most importantly, Powell revealed that “there is a feeling in some we should wait.” Since there was just one vote for waiting during the latest meeting, I assume Powell referred to waiting instead of cutting in December – a not so subtle hint that the Fed as a group may already prefer not to cut in December.

The Case for A December Cut Still Looms

However, the hesitancy to cut in December directly contradicts Powell’s assessment of the economic situation. Powell noted that the current rate is above the neutral rate (“wherever it is”). Thus, policy is technically restrictive. Importantly, Powell ascribed the cooling in the labor market and the economy to restrictive policy. So if the Fed has truly adopted the mission to focus on addressing the downside risks in the economy, the Fed must stay biased to cut rates. At this point, the Fed will have a very difficult time explaining how it can “stand by” and watch a weakening economy and labor market.

While there remains upside risk to the Fed’s inflation mandate, Powell makes a weaker and weaker case every meeting that the Fed is truly concerned about that risk. He said plenty to indicate that the prospects for inflation are contained and even tame. Here were his main points on inflation:

• Most measures of long-run inflation expectations remain consistent with the Fed’s 2% inflation target.
• Services inflation is coming down
• Higher tariffs are pushing up inflation as one-time increase in the price level (the base case)
• The core PCE (personal consumption expenditures, the Fed’s preferred measure of inflation) without tariffs would be 2.3% or 2.4% without tariffs, not far from the 2% target.
• The tariff-driven increase in goods prices is happening within the longer-term context of goods deflation.

Thus, once the base case of a one-time effect laps the inflation readings, the Fed should be comfortably close to its target.

While Powell reiterated that the Fed is determined to make sure that the inflationary impact of tariffs is indeed a one-time increase in the price level, the overall picture painted by Powell makes inflation look well-contained. The implied upside risk from the uncertainties in tariff policy hardly seem noteworthy in Powell’s updated narrative.

On the other hand, Powell claims there is “no significant deterioration” in the economic data. While Powell pointed out that the downside risks to employment have risen, he did not express any concern for the highly publicized mass layoffs from big companies like Amazon.com (AMZN) and United Parcel Services (UPS). In response to a question about these layoffs, Powell only said that the Fed is watching these developments, and the layoffs do not yet show up in the initial claims data (of course not – these layoffs are recent announcements).

Overall, Powell sums up the labor issue as low hiring and low firing in the context of immigration policies shrinking the labor supply and a cyclical drop in the participation rate in the workforce. When asked how then will rate cuts help the job market, Powell responded that cuts will make sure the “labor market doesn’t get worse.” Upon hearing that explanation, I felt tingles of recessionary risks.

Inflation Warnings from Overseas?

While Americans are mostly focused on the inflation risks from tariffs, inflation is also proving stubbornly sticky in other major economies who are not at war with the global economy. For example, with inflation at 3.8% in the United Kingdom, the Bank of England is further away from its 2% inflation target than the Federal Reserve is from its target. In its last letter explaining the on-going inability to hit the target, the BoE reported:

“The recent increase in CPI inflation has owed largely to food prices and administered prices, including water bills and Vehicle Excise Duty. A reduction in total labour cost growth also appears to have been delayed by the increase in employer National Insurance Contributions (NICs) and pay growth in sectors with a large share of employees at or close to the National Living Wage (NLW).”

Yet, the BoE expects this year’s inflation increase to peak in September. The combination of a weakening labor market and restrictive policy is expected to help push inflation toward the 2% target next year. This is the UK version of hopeful monetary policy. The BoE just made its last rate cut in August, going from 4.25% to 4.0%. The policy rate was left unchanged in the last meeting.

Earlier this week, inflation in Australia hit its highest point in over a year. With inflation now above the Reserve Bank of Australia’s target band of 2-3%, the RBA will likely need to put a pause on its easing cycle. The Australian Bureau of Statistics identified housing, recreation and culture, and transport as the main drivers of inflationary pressures. A likely pause in easing further strengthened my case to stay long the Australian dollar (FXA).

I am now on heightened alert for sticky inflation becoming a global problem that justifies an extended run for the debasement trade.

A Pause in the Debasement Trade

As the Fed expresses hesitancy about cutting rates again in December, the debasement trade took a major pause going into the Fed meeting, perhaps in anticipation of a less dovish Fed. Given I think the Fed will feel compelled to proceed with cuts in December, I consider the pause in the debasement trade to be even more temporary than the inflationary pressure from tariffs. I have treated this sharp pullback as the buying opportunity I have (mostly) patiently waited for. When parabolic rallies finally lose steam, the pullbacks are often swift and steep. I am looking for support to hold for the SPDR Gold Shares (GLD) by the $350 level where the 50-day moving average (DMA) (the red line in the chart below) awaits testing.

Bond yields understandably spiked higher in response to the Fed’s balk on rate cuts. However, I am no longer interested in trying to fade rallies in the iShares 20+ Year Treasury Bond ETF as I now accept that the bond market’s overall trajectory is to worry much more about imminent economic weakness than lingering inflationary pressures.

The bond market is giving the Fed a green light for rate cuts. Thus, today’s balking should gradually transition to acceptance in the coming weeks.

Be careful out there!

Full disclosure: short GLD put, long GLD calendar call spread, long UPS, long AMZN put spread

The post Powell Balks At the Next Step of Hopeful Monetary Policy appeared first on Inflation Watch.

“…shelter costs, a third of the CPI. Think about the chicken and the egg. If if the Fed lowers rates, you wind up having lower mortgage rates. You wind up having lower CPI, right. So for me, they’re enforcing that higher CPI by not cutting rates. So if you could cut rates a third of CPI comes down, a third of CPI comes down….Used car prices. Why aren’t used car prices moving down? Interest rates. So you have mortgage rates, interest rates for used car prices. Everything that the Fed is doing is fostering higher prices”.

Almost as surprising was that no one challenged this flawed understanding except to object to the use of the transitive rule (if A = B and B = C then A = C). Even CNBC’s famous bond expert Rick Santelli joined the discussion and failed to correct these assertions. (Fortunately, he agrees that inflation is a problem for the Federal Reserve). I am guessing these assertions were not ad hoc and came from somewhere that others consider to be an authoritative source, so I feel compelled to offer a correction.

First of all, the U.S. Bureau of Labor and Statistics (BLS) started phasing out financing costs from the CPI in the early 1980s. At the time, the Fed was fighting inflation with aggressive rate hikes and the inclusion of financing costs in the CPI made it hard to explain monetary policy. Thus, the current definitions of items in the CPI exclude financing costs both implicitly and explicitly. The BLS describes the inclusions and exclusions for the CPI in “Consumer Price: Concepts” where it explains that “interest costs and finance charges are…out-of-scope”.

Financing Costs Are Not Consumption Goods

Shelter costs are not based on the price of a home or its financing. Instead, the BLS uses Owner’s Equivalent Rent (OER) which is the amount a household would have to pay to rent their home.

“Using the sample of rental units, the CPI program calculates a measure of price change for each CPI index area for the rent and OER indexes. The first step is standardizing the collected rents so that all rents are on a monthly basis. These standardized rents are called normalized rents. The normalized rents are then adjusted for any quality changes such as an additional bedroom or bathroom, changes to the type of heating and cooling equipment, and changes in extra charges such as an increase in total pet fees. The CPI program also adjusts rents for the effect of aging over time. Rents are collected for the same housing units every 6 months. Consequently, each time the CPI observes the rent of a sample unit, it is 6 months older. To account for this aging, an age-bias factor is applied to the previous rent.”

There is nothing in the definition that mentions mortgage rates. The BLS considers the mortgage as part of capital and not consumption.

“Interest costs (such as mortgage interest), property taxes, real estate fees, most maintenance, and all improvement costs are part of the cost of the capital good and are also not treated as consumption items. These non-consumption costs of owned housing are out of scope for the CPI under the cost-of-living framework that guides the index.”

Similarly then, the cost to finance a car, used or new, is also the cost of the capital good and is excluded from the CPI. Here is the core of the BLS’s explanation for measuring the inflation for new vehicles:

“The new vehicles index is estimated using a transactions dataset purchased from J.D. Power that includes observed transaction-level prices and detailed vehicle information. Each observation includes a transaction price as well as a set of 40 variables including rebate values and vehicle characteristics. Sales tax rates are applied by BLS for index calculation….

The BLS also relies on prices from J.D. Power to calculate an inflation rate for used vehicles and does not include financing costs.

Hot and Sticky Inflation

While various pundits torture the data to make specific points about the insignificance or transitory nature of today’s inflation, the core CPI is actually trending higher. The upward trend confirms the bottom telegraphed by the July Beige Book.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PCEPILFE; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPILFESL, September 11, 2025.

From my perch, I still see all systems go for hot and sticky inflation. I see only additional inflationary pressures from rate cuts. Turkey learned this lesson, and much of the Federal Reserve acknowledges (or used to acknowledge?) the inflation risks. But we are officially climbing the stairs of hopeful monetary policy…hoping that the rate cuts can heal the employment market faster than it can stoke higher inflation.

Be careful out there!

Full disclosure: no positions

The post Financing Costs Do Not Impact Calculated Inflation appeared first on Inflation Watch.

In his speech at the annual Jackson Hole confab, Powell acknowledged that “with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance” (emphasis mine). In normal times, with this ever so slight tweak in Powell’s inclinations and probabilities coming at the end of a long explanation of the balance of risks to inflation, employment, and the economy, this concession could be interpreted as another tease in the on-going suspense and fight over rate cuts. Instead, a stock market ever more eager for rate cuts built a temple from a single stair step and responded with one of the biggest expansions in market breadth that I have ever seen.

Maintaining high odds of a September rate cut will effectively force the Fed to cut. However, if Powell stays on message – “monetary policy is not on a preset course” – then the September rate cut could easily lead to a major disappointment. The Fed’s voting majority may not be ready to promise a sustained rate cutting cycle because inflation remains a nagging problem for the Fed.

Even before the tariff drama, trauma, and noise, inflation was proving itself sticky and stubborn. Now, core CPI (Consumer Price Index) and core PCE (Personal Consumption Expenditures), the Fed’s preferred inflation measure, look like they have bottomed. Core CPI has even started heading upward largely thanks to a lift in services inflation. As a result, not only is the Fed looking to cut rates well short of its 2% (core PCE) target but also just as inflation’s downtrend is taking an extended pause.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis, August 25, 2025.

A suddenly very hot Producer Price Index (PPI) from July promises that subsequent CPI reads will not deliver inflation relief.

Moreover, tariff-driven inflation is already showing up both in the anecdotes from business leaders, earnings reports, and the Fed’s own research. Moreover, even though the Fed Funds rate is still in restrictive territory, financial conditions are not tight. In fact, financial conditions were last this loose right before the Fed belatedly started hiking rates in early 2022.

All together, these stories provide cautionary tales for rate cuts. The confidence I observe in the “rate-cutters” shows insufficient deference to the stagflationary possibilities in the economy. Powell characterized the potential as “a challenging situation” after he finished explaining how “in the near term, risks to inflation are tilted to the upside, and risks to employment to the downside”. This position between a rock and a hard place motivates me to tighten my grip on my position in Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP).

A Swirl Of Claims and Counterclaims

At this point, every one has an opinion on what the Fed needs to do. I have taken note of some key interviews and speeches to portray the painful complexity of the task ahead for the Federal Reserve. Anyone who claims with confidence that the Fed should do “X” is glossing over some part of this picture.

Cleveland President Beth Hammack Leans Against A Rate Cut

Interviews like the one with Cleveland President Beth Hammack formed part of the reason the stock market got caught leaning away from Powell’s first step on the stairs of hopeful monetary policy. A day before Powell’s speech, Hammack insisted that “with the data in hand right now, if the meeting was tomorrow, I would not see a case for reducing interest rates”. She warned that her “biggest concern is that inflation has been too high for the past 4 years. And right now it has been trending in the wrong direction [see chart above]. It’s important we stay modestly restrictive to make sure inflation is brought back under control” (Hammack’s predecessor expressed similar concerns earlier in the month).

Hammack also worried that the inflationary impact of tariffs are just getting started and will continue into Q1 and Q2 of next year given the timing of contract renewals. These worries did not sound like the setup for an incrementally conciliatory Powell.

Hammack also stated that “financial conditions are broadly supportive of the economy” (consistent with the ANFCI). Moreover, she is “not hearing interest rates are a huge problem”. The builders and businesses building new plants in Hammack’s district are complaining just as much about the cost of materials and labor as they are about high interest rates. In a case for future inflationary pressures, manufacturers in the Cleveland district have been buffering price increases but cannot not sustain the hits “forever”.

I surmise Hammack will vote against a rate hike in September. Will she suddenly find herself on the dissenting side of the ledger?

Former St. Louis Fed President Jim Bullard Bolsters Candidacy As Next Fed Chair

Candidates for position of the next Fed Chair share a common trait. They think tariffs will not cause lasting inflation and support cutting rates right away. Former St. Louis Fed President Jim Bullard is a recent add to the candidate list. In a CNBC interview on August 12, Bullard insisted tariffs do not cause inflation. Tariffs are a tax and taxes do not cause inflation (a common equivalence). He pointed to data showing very muted effects and claimed that tariffs are not interrupting the longer-term trend to 2% inflation. Like other supporters of rate cuts, Bullard is looking well beyond the current swirl of data and glancing at the top of the stairs of hopeful monetary policy.

Council of Economic Advisers Chair Stephen Miran Asks “What Inflation”?

Council of Economic Advisers Chair Stephen Miran is also on the list of potential candidates to next head the Fed. Miran appeared on CNBC the same day as Bullard to discuss the economy. By narrowing his view to inflation since inauguration, Miran calculated a 1.9% annualized rate of inflation (I assume this was a reference to headline inflation). He further insisted that there “continues to be no evidence whatsoever of tariff-induced inflation”, and he implied that there will be no evidence for future impacts either. Ultimately, exporters will bear the cost of tariffs because they are the least flexible part of the supply chain; Americans will just buy elsewhere or make formerly imported goods domestically (do exporting countries doing deals understand their ultimate doom?).

When asked about the bottoming in core inflation, Miran dismissed the dynamic because tariffs are not the culprit. Miran pointed to used cars and airfares as core drivers. He went on to finger illegal immigration for boosting rents by 4-5%. Thus, net services inflation will go to zero because of the current crackdown on illegal residency.

Miran stands confidently at the top of the stairs of hopeful monetary policy. I am guessing he is a front-runner in the race for Fed Chair.

Gold Paralyzed With Indecision?

The price of gold has largely stopped responding to the back and forth in inflation-related data and opinions on monetary policy. While the SPDR Gold Trust (GLD) increased 1.1% in the wake of Powell’s first step on the stairs of hopeful monetary policy, GLD remains firmly stuck in a 4-month trading range. A technical “bearish engulfing” pattern in April continues to loom over the trading action as a top. Still, I am betting on GLD responding bullishly to the next rate cut just as it did to the last one. GLD is up 30% after initially selling off in response to what was thought to be a hawkish rate cut at the time.

I have been holding a GLD calendar call spread for the last half or so of this trading range while rolling forward the expiring short ends of the spread. I plan to convert this position to an outright call spread ahead of the September Fed meeting.

Be careful out there!

The post Powell Places His First Step On the Stairs Of Hopeful Monetary Policy appeared first on Inflation Watch.

Each Fed region told slightly different stories about their respective inflationary pressures. A few regions are even enjoying some type of price stability for now. Still, the anecdotal evidence on the whole supports the notion that tariffs cause prices to rise and the price impacts can cascade in uncertain ways.

Boston

Boston produced benign inflation commentary. Prices may be stabilizing. According to the Boston observers: “Most contacts expected to hold their own prices steady for the rest of the year, as some perceived strong consumer resistance to further price increases. Tariffs were expected to drive seafood prices higher going forward, but risks of rising inflation were mentioned less frequently than in the previous report.”

New York

The commentary from New York was the exact opposite of Boston. Perhaps reflecting a higher rate of international commerce in the New York region, this region delivered some of the sharpest inflationary commentary: “the pace of input price increases remained steep as tariff-related cost increases were widespread. Many businesses reported continuing to pass on some or all tariff cost increases to their customers.” Tariffs drove up the costs of steel inputs and auto parts. While businesses indicated there are limits to their ability to pass on prices – “businesses expected substantial increases in input prices in the months ahead, but more moderate increases in selling prices” – one retailer reported a creative solution by raising prices on products with inelastic demand. This pricing strategy could gain popularity as tariffs push higher prices across the economy and businesses scramble to accommodate without crushing demand.

Philadelphia

This region reported some pricing pressures in the forms of discounts from the retail, tourism, and residential construction sectors. The pricing pressures facing builders have slowly increased this year. One firm even received price relief on insurance for the first time in a few years. While tariff-related pricing pressures have been lower than expected so far, businesses expect larger tariff impacts in coming months.

Cleveland

Perhaps because of heavy industries with a dependence on highly tariffed inputs, Cleveland seems to be getting hit hard by cost pressures: “contacts’ reports indicated that nonlabor input costs continued to rise at a robust pace in recent weeks and that the cost stabilization seen during 2024 had dissipated.” The strong pace of price increases in imported, tariff-impacted materials and tariff-impacted retailers leads contacts to generally expect “costs to grow at a strong pace in the coming months.” The banking, professional, and business services sectors have even experienced higher costs for technology, including AI and data security. (Cleveland was the only region to report such higher costs, but I doubt they are or will be the only one hit given the broad need for this technology). Firms in Cleveland are raising prices to respond to tariffs, but they are somewhat constrained by price sensitivity in their marketplaces.

Richmond

Richmond had little to say about prices. The most notable comment came from a firm that has suffered increased costs throughout its business: “One manufacturer said that input costs were higher in recent months due in part to tariffs but also from rising regulatory, insurance, and labor costs, including wages and benefits.”

Atlanta

In Atlanta, businesses are trying every trick in the book to manage tariff-related risks and price pressures: sharing costs between suppliers and customers, changing supply chains, drawing down on pre-tariff inventories, pre-emptive price hikes, and wait-and-see. I expect this broad palette of strategies to unfold nationwide.

Chicago

Business in Chicago expected the same pace of inflation going forward as the “moderate” rate they saw from late May to June. Higher material costs were the highlight for manufacturers surveyed in the region.

St. Louis

Businesses surveyed in St. Louis described a mix of absorbing the increased costs of tariffs and passing along higher costs to customers.

Minneapolis

Beating Boston, Minneapolis had the most benign commentary on inflation. Businesses in Minneapolis actually reported a slower pace of inflation than the previous month. This region quantified its survey as follows:

• About a quarter of District firms increased the prices they charged to customers in June from a month earlier.
• About the same percentage anticipated increasing their prices in the month ahead.
• Slightly less than half of respondents reported increased input prices over the previous month.

Kansas City

Profit margins shrank in Kansas City as businesses were not able to pass on the full extent of increased input costs. Companies may have absorbed all they can at this point given “some firms reported they are planning broad-based price increases across product lines to maintain profitability.”

Dallas

Despite a range of reports of higher costs for input materials, “expectations for 12-month price growth eased slightly in June compared to March.”

San Francisco

Inflationary pressures remained the same from the June to the July Beige Book. The pressures are also broad-based: “Price increases were reported across a wide range of industries.”

Inflation Will Stay Resilient

On balance, the Beige Book confirms that, at best, inflation going forward will hang around current levels. Gone is the glide path downward that reassured the Fed about cutting rates. The June CPI report suggests that inflation has bottomed out. A nudge from tariffs could put in place a new uptrend as higher price levels settle out through the country.

The Fed is unlikely to hit its 2% inflation target anytime soon.

The Noise

While inflationary pressures build, pressures build on Chair Jerome Powell o resign or get fired. The drumbeat of acrimony now seems like a lot of noise. Like the tariff drama, trauma, and noise, the Powell versus Trump drama is mainly headline fodder until something happens. Wednesday’s (July 16) news was case in point. Headlines screamed Trump was ready to fire Powell, bonds fell, and then Trump refuted the rumor. The iShares 20+ Year Treasury Bond ETF (TLT) almost tested its low for the year before rebounding sharply.

I used the sharp dip to buy TLT $87 call options expiring in August. The trade bets on another relief rally following a sharp sell-off. I expect to return to fading rallies in due time.

Be careful out there!

Full disclosure: long TLT calls

The post July Beige Book Reinforces A Bottoming in CPI appeared first on Inflation Watch.

While it is far from clear how tariff-driven price hikes will eventually shake out, the Fed districts offered sufficient evidence of businesses who have price hikes waiting in the wings.

In Boston, a clothing retailer retagged products for sale this summer with higher prices than planned before tariffs.

In New York, manufacturers claimed they plan to pass along most or all of tariff-driven price increases. Moreover, “businesses continued to expect substantial increases in input prices in the months ahead.”

In Philadelphia, “more than two-thirds of the surveyed firms anticipated increased costs and expected their competitors to increase prices in as little as two months.” Yet, about half of Philadelphia respondents reported increased price sensitivity amongst its customers.

In Cleveland, businesses expect a “strong pace” of growth in costs”, particularly with nonlabor input costs rising “at a robust pace in recent weeks.”

Firms in Richmond expect prices to rise faster in the coming 6 months.

In Atlanta, some firms pushed through price increases despite softening demand, a troubling prospect of potential stagflation. Most interesting are the firms using “a multi-pronged approach to managing tariffs, including pushing costs back to suppliers, reconfiguring supply chains, absorbing costs in margins, and passing costs through to customers.”

In Chicago, businesses expect higher inflation over the next 12 months.

In St. Louis, “most contacts expecting nonlabor costs to increase next quarter reported that they would pass along the costs to customers within three months.”

In Minneapolis, more than half of surveyed business claimed they plan to increase prices in the coming future.

Kansas City businesses “generally [anticipate] higher input and output prices in the coming months.” Cost increases from the surge in demand for shipping products ahead of tariffs will be passed on to customers in the next 12 months.

Oilfield services firms in Dallas are having trouble passing along higher costs to customers. Of the Texas businesses who feel able to pass along tariff-related costs, “about 60 percent are doing so within a month of the tariff taking effect, and 90 percent are doing so within three months.”

San Francisco did not provide anecdotes or data on planned price hikes. However, one alarming anecdote came from a business which noted that tariff-related price hikes were not rolled back along with the related rescinded tariff. This inflation “stickiness” is a worrying indicator of how tariff-driven price hikes can cause lasting, cascading price pressures in the economy.

Given these consistent and confirming anecdotes and data points, the CPI looks set to bottom out in coming months if not in the very next report. With Beige Book in hand, the Fed is unlikely to cut rates ahead of more certainty on tariff policy. These reports from the Federal Reserve’s districts underline Jerome Powell’s core desire to see the economic warfare, primarily through tariffs, come to an end.

The Downtrending CPI Is Also Colliding With A Weakening U.S. Dollar

While May’s CPI came in softer than “expected”, its descent still slowed since March’s big drop. The reports from the Beige book suggest that this downtrend could continue if not for tariff-driven price pressures. Instead, fresh inflation agitation likely awaits.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis. June 12, 2025.

In the meantime, the U.S. dollar continues to weaken. At the time of writing, the U.S. dollar index (DXY0) briefly broke down below its 3-year low set back in April. A weaker dollar means imported goods become more expensive, all else being equal. Thus, the weaker currency will translate into higher inflation in the U.S. except to the extent demand for imported goods falls along with the dollar.

Source: TradingView

Be careful out there!

The post A Calm Before Fresh Inflation Agitation? appeared first on Inflation Watch.

• The Federal Reserve had driven monetary policy to historic heights of accommodation: a 9 trillion dollar balance sheet combined with a return to zero interest rates: an easy money paradigm that itself needed to be transitory.
• The Federal Reserve instituted a risk management framework that targeted tail risks instead of an “expected” path of inflation and its resulting impact on the economy.

Moreover, Stiglitz offered two examples from the economy, autos and shelter, that do not conclusively demonstrate the Fed had no impact on inflation. Even Stiglitz’s discourse on inflation expectations is open to varying interpretations. I will tackle each of these issues one-by-one starting with auto inflation.

Auto Inflation: A Counterfactual

Stiglitz makes a big deal out of the obvious fact that the Fed could not solve chip supply problems in the auto industry by hiking interest rates. While the Fed never staked a claim to such powers, and even acknowledge its lack of such powers, this complaint is common among Fed critics who apparently wanted the Fed to leave monetary policy accommodative and lower for longer. Stiglitz pulls the rug from under the Fed by insisting “Given that its interest-rate hikes did not help resolve the chip shortages, it cannot take any credit for the disinflation in car prices.”

So now with auto prices inevitably lower, critics like Stiglitz are declaring victory on the prediction that car prices would eventually come down. Fine. How about a counterfactual? If the Fed had left rates lower for longer is it credible to believe that the path for prices would have stayed exactly the same (or improve)? I claim the answer is no. Assuming lower loan rates encourage and incentivize more borrowing (indeed this is a fundamental premise for accommodative monetary policy), then rock bottom rates would have fueled on-going and even increasing demand for cars and deepened pressures against short supply. In other words, I am claiming auto inflation would have been even worse and could have caused other cascading problems in the economy.

Even throwing away abstract counterfactual arguments, the actual data is not conclusive enough to suggest the Fed had zero (or even little) impact. The chart below juxtaposes new and used car prices with the auto inventory/sales ratio (cars and light trucks). This ratio puts demand and supply into context. While the the ratio bottomed out in late 2021, it is still nowhere close to pre-pandemic levels. Deflation/disinflation should not be this dramatic with the inventory/sales ratio still at historically low levels. I would have expected a price plunge to accompany a much faster recovery in the inventory/sales ratio. In fact, I would have expected the pendulum to at least swing above 1 again.

Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Used Cars and Trucks in U.S. City Average [CUSR0000SETA02], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: New Vehicles in U.S. City Average [CUUR0000SETA01], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Economic Analysis, Auto Inventory/Sales Ratio [AISRSA], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

In other words, while supply has been slowly normalizing, demand still outstrips supply. This is a condition for higher prices. Yet, resurgent inflation in autos is not likely specifically because high interest rates are constraining and reducing the ability and willingness to pay higher and higher prices. The rate on the 48-month auto loan was last this high in 2002.

Source: Board of Governors of the Federal Reserve System (US), Finance Rate on Consumer Installment Loans at Commercial Banks, New Autos 48 Month Loan [TERMCBAUTO48NS], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Finally, domestic banks have also tightened lending standards, likely further constraining the ability to pay higher prices. Lending standards tighten with tighter monetary policy as banks become more risk averse and have a higher cost of funds. This is a Fed effect. From the October, 2023 “Senior Loan Officer Opinion Survey on Bank Lending Practices“:

“In a set of special questions, banks were asked to assess the likelihood of approving credit card and auto loan applications by borrower FICO score (or equivalent) in comparison with the beginning of the year. Significant net shares of banks reported that they were less likely to approve both credit card and auto loan applications from borrowers with FICO scores of 620. Moderate and significant net shares of banks reported that they were less likely to approve credit card loan applications and auto loan applications, respectively, from borrowers with FICO scores of 680. In contrast, a modest net share of banks reported being more likely to approve credit card applications from borrowers with FICO scores of 720, while the likelihood of approving auto loan applications to borrowers with FICO scores of 720 was basically unchanged in comparison with the beginning of the year.”

Thus, I claim the Fed deserves at least partial credit for helping to tap the brakes on demand, in the form of ability to pay, in the face of relatively tight inventories. In other words, I find it compelling to create a narrative around a Fed impact that is at least as plausible as the narrative that completely discredits the Fed.

Shelter Inflation

The dynamics of shelter inflation are complex. I grant Stiglitz the point that higher interest rates can exacerbate inflationary pressures by reducing the availability of construction loans needed to increase supply. Interestingly, Stiglitz does not reference the complementary constrain t on supply from existing home owners who refuse to move and incur the cost of mortgages more expensive than their current ones.

Anyway, I will still point out that it was soaring shelter inflation that provided the signal to the Fed that rates were overly accommodative; the episode was a rare moment in Fed history where it acknowledge an inflationary problem from shelter costs. Historically low mortgage rates stoked demand and led to a mini-mania in the housing market. Prices soared practically uncontrollably for homes. Rent soared alongside home prices. I discussed the “housing trigger” for the Fed in “The Federal Reserve Fears On-Going Inflationary Pressures from Rents” and provided more detail in “Inflationary or A Bubble – Housing Prices Help Push A Fed Driving Recession-Pricing for Home Builders.”

I also provided evidence from a home builder about the impact of the Fed on cooling housing prices in “Lennar Corporation: How the Fed Is Cooling Inflation In the Housing Market.”

In other words, the mere fact that one-year leases on rents cause a lag in disinflation is insufficient to dismiss the various ways in which rent inflation forced the Fed to hike and to maintain its hiking campaign. A counterfactual on post-pandemic housing demand and prices in the face of prolonged accommodative policy should not be controversial: we have lived it three times in the span of just one generation.

Core Inflation

Stiglitz noted the following about headline inflation:

“The pandemic-induced inflation was exacerbated further by Russia’s invasion of Ukraine, which caused a spike in energy and food prices. But, again, it was clear that prices could not continue to rise at such a rate, and many of us predicted that there would be disinflation — or even deflation (a decline in prices) in the case of oil. We were right. Inflation has indeed fallen dramatically in the United States and Europe.”

This was a surprising sidebar when the Fed does not set monetary policy by what happens to food and energy. Adding to the distraction, Stiglitz does not label the inflation numbers her uses to compare to the Fed’s target. For the purposes of this discussion I will assume he is referring to core PCE (personal consumption expenditure, excluding food and energy) since it matches the number he uses for September. Yet, I cannot be 100% sure since the 3.7% change in the PCE in September matches the 3.7% headline change in the CPI (consumer price index) for September. This confusion is technically important because the median PCE sits at 4.4%. Core CPI was 4.1% in September, and the October report delivered the tiniest of cooling at 4.0%.

No matter the lens, these levels and incremental declines are hardly an occasion for final victory. While the Fed has every reason to stop hiking rates and watch what happens from here, these numbers do not tell me the Fed can pack up its toys and go home. Stiglitz takes care of that concern by calling the 2% inflation target arbitrary: “There is no evidence that countries with 2% inflation do better than those with 3% inflation; what matters is that inflation is under control. That is clearly the case today.” On the surface, the logic makes sense except that the period of “Great Moderation”, where deflation was the Fed’s biggest concern, was a period where PCE stayed below 2%. We do not have experience in THIS economy with a Fed that overtly allows inflation to stay well above 3%…and the Fed is clearly in no mood to push its luck.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Inflation Expectations

Stiglitz claims that the Fed also had nothing to do with controlling inflation expectations. Unlike the Fed, markets knew that inflation would naturally correct itself. Stiglitz even challenges the protest that inflation expectations remained calm specifically because of trust in the Fed: “…inflationary expectations remained tame. While some central-bank economists claim that this was due to their own forceful response, the data tell a different story. Inflation expectations were muted from early on, because markets understood that the supply-side disruptions were temporary.” Stiglitz took a debatable point and breathed unfounded certainty into it. Stiglitz focuses on the 5-year forward inflation expectation rate:

“Only after central bankers repeated over and over their fears that inflation and inflationary expectations were setting in, and that this would necessitate a long slog entailing high interest rates and unemployment, did inflationary expectations rise. (But, even then, they barely budged, reaching 2.67% for the average of the next five years in April 2021, before falling back to 2.3% a year later.)”

Yet, a different interpretation is plausible and valid regarding the stability in the 5-year forward expectation. It appears the market has a bias to expect disinflation (especially in response to shocks). Starting between 2015 and 2017, the market finally believed the Fed could hold inflation closer to 2.0%. This milestone came after persistent messaging, in different forms, from the Fed on the 2% target. It seems odd to blame the Fed for a brief spike in inflation expectations at the time the Fed started hiking rates. I find it more plausible to interpret the rapid return to previous levels as evidence the market was once again mollified over long-term prospects with a Fed clearly serious about constraining inflationary pressures.

Source: Federal Reserve Bank of St. Louis, 5-Year, 5-Year Forward Inflation Expectation Rate [T5YIFR], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Given it appears to take a lot to convince markets the Fed cannot control inflation over the “long-term”, I turned to shorter-term expectations as a more responsive indicator. It turns out that the 3-year consumer expectations peaked right as the Fed finally dropped the notion of transitory inflation in November, 2021. One-year expectations kept rising alongside inflation readings and peaked with a peak in inflation. Thus, it is very possible that the 3-year expectation more accurately reflects sensitivity to the Fed’s actions where it counts: consumers.

Source: Federal Reserve Bank of New York, Survey of Consumer Expectations

I go into more detail about the mechanics of inflation expectations in “Inflation Expectations and Inflationary Psychology.”

Since short-term expectations can start to bleed into longer-term expectations for inflation, the Fed took a risk management approach when it finally got serious about inflation. Tamp down short-term expectations and remove the risk of perturbing longer-term expectations which could prove harder to control above recent historical ranges.

The Risk Management Approach to Monetary Policy

The question is not whether or not the Federal Reserve should have acted to normalize monetary policy (by picking a non-zero target). The question is how far does/did the Fed need to go. Powell made it abundantly clear that the uncertain (and unprecedented) economic environment put the Fed in a risk management framework. The Fed decided it could not manage policy to the average or expected outcomes in the economy.

For example, a year ago, during the Q&A at a Brookings Institution conference, Powell claimed that monetary policy must take into consideration tail risks and their costs. The Fed collectively had decided that the costs of high inflation outweighed the potential risks of expeditiously hiking rates. The economy has proven so resilient that economists have spent over a year and half pushing out forecasts for a recession, a recession that could have been the main transmission mechanism for monetary policy to tank prices. Now, with the market celebrating the end of rate hikes and declaring victory over inflation, the runway is clear for the soft-landing narrative. I suppose those folks who think the Fed had no influence over inflation will have to conclude that monetary policy is totally meaningless if a recession is not forthcoming!

Conclusion

The inflation debate will never end because participants often bring to the table strong assumptions about the Fed’s capabilities and over-confidence in understanding the intricacies of the post-pandemic economy.

Ultimately, I stand by my long-standing claim that the Federal Reserve acted too slowly as supported by later economic research that I covered last June in “Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge.” I stake no claim on the ultimate target; I just claim that the Fed needed to start normalizing sooner given what could be known at the time about economic conditions and the massive monetary and fiscal stimulus in the economy. Stiglitz did not explicitly say that he would have preferred the Fed do nothing, but his stance implies as much and feeds the narratives that inflation was never a problem in the first place. Thus, the Fed cannot satisfy anyone, not the inflationistas like myself nor the disinflationistas like Stiglitz….and certainly not the deflationists who held sway for so long going into the pandemic.

Be careful out there!

The post Despite the Inflation Celebrations, the Case Against Team Transitory Still Stands appeared first on Inflation Watch.

The above graph shows that services inflation is the main culprit keeping core CPIH in an uptrend. Core CPIH dropped from 6.5% in May to 6.4% in June. Since May was a 30-year high, I am particularly unimpressed by the “pullback” in the core inflation rate. The Core CPI (Consumer Prices Index) dropped from 7.1% in May, a 31-year high, to 6.9% in June.

Food and energy inflation is coming off extreme levels. Food inflation is coming off a peak 19.2% in March, 2023. Fuel prices are outright plummeting, falling 13.1% in May and 22.7% in June.

The British Pound Cools with Inflation

The cooling overall inflation numbers cooled the heels of the British pound which has been on quite a streak since the bond and currency crisis 10 months ago. GBP/USD, also Invesco CurrencyShares British Pound Sterling Trust (FXB), was falling off a near 16-month high coming into the inflation print. The inflation report greased the skids on the way to an important test of the uptrending 20-day moving average (DMA). That line has held as support since the beginning of June and has been important support since early March.

Source: TradingView.com

For now, I am trading for a bounce from the 20DMA and prepared to to accumulate a larger position for a test of 50DMA support. The overall drivers of sterling strength seem intact as long as core inflation is uptrending or even just sticky. The Bank of England will have to remain as hawkish as ever.

Of course, the upcoming meeting of the U.S. Federal Reserve is a major wildcard. If the Fed manages to get hawkish enough to scare some fresh strength into the U.S. dollar, then I will have to drop my current trading strategy.

Regardless, the uptrend in the pound should at some point end in the coming months. This recent weakness in the currency could be the beginning of the end.

Be careful out there!

Full disclosure: long GBP/USD

The post Is the British Pound Topping Despite Lingering Strength in UK Core Inflation? appeared first on Inflation Watch.