For the second month in a row, there is clear good news on the inflation front from the U.S. The consumer price index report for November revealed the pace of overall inflation is elevated but the upward price pressures on the goods and consumables households rely on have increased by less than most economists anticipated, suggesting the Fed's fight against inflation is starting to bite.
“Today’s report marks another month of disinflation,” says Preston Caldwell, chief U.S. economist.
“It’s way too early to be popping champagne corks, but getting more certainty that inflation is normalizing is probably a good thing,” he added.
Of particular good news on the inflation front came on the goods side of the report, where prices outright fell on a range of items including autos, a cross-section of consumer electronics, toys, furniture or other household goods. The November C.P.I. was careering the right way, and there was much rejoicing in the markets, both in the form of stocks that rose and bond yields that plunged. The CPI report is not expected to alter the outlook for the Fed’s decision on interest rates this week, when policy makers are likely to lift short-term interest rates by another half-point.
But if progress on inflation continues, that could mean the Fed does not have to push rates as high as some in the markets have been expecting and could clear the way for a quicker pivot for the Fed to a rate-cutting stance next year. But caveats remain. The broader trend of inflation on an annual basis is still comfortably above the Fed’s 2% goal. Inflation in services, a particular focus of the Fed, also remains high, and with strong job growth continuing, some economists are concerned that that may put a lid on potential progress against inflation unless the economy starts indicating more widespread signs of slowing.
The good news from the November CPI report
According to the U.S. Labor Department, the consumer price index, or CPI, increased 0.1% in November, slightly below the 0.3% gain economists were forecasting and that followed a 0.4% gain for October. Core CPI, which excludes the volatile food and energy categories, were up 0.2% in November, also weaker than had been expected and lower than the 0.3% reading in October. The gain in core CPI in November was the smallest since August 2021.
The inflation rate eased to 7.1% on a year-over-year basis in November. CPI, excluding the often-volatile categories of food and energy, increased 6.0% in November from a year earlier. Both readings were weaker than economists had expected, according to FactSet.
"As always, we try to remove the noise of focusing so much on just a single month - which is incredibly noisy - by looking at a moving average," Caldwell says. “Core” inflation rose at an annualized rate of 4.3 percent in the three months ending in November, down sharply from the 6 to 7 percent-like annualized pace it was running in the first three quarters of 2022.
The outlook for shelter costs
Housing fell within one of the most closely watched categories of inflation tracked in the report, as “shelter” prices slipped in the report.
“Shelter grew at an 8.9% annualized rate over the past 3 months, and that was enough to single handedly support (core) inflation due to the weight of shelter,” Caldwell says. “But we have considerable cause to ignore the big jump in CPI shelter prices, as they follow well behind the market in normal times.”
The high November numbers for shelter costs make sense to Caldwell; they’re a direct result of very high inflation in market rents as measured by indexes such as Zillow’s Observed Rent Index over the past two years.
“But those same market rents are slowing precipitously now,” Caldwell notes. And the Zillow index has risen at an annual rate of only 3.5% over the past three months.
Another bit of good news in the report is another inflation metric: Core inflation excluding shelter.
“Perhaps more striking, core CPI ex-shelter slowed to a 1.1% annualized pace in the three months ending in November,” Caldwell writes. "Core goods prices are outright deflation — down at a 3.5 percent rate.
“It’s being fueled by a whole lot of things, but the rolling over of the price spike in used autos is a big part of it,” Caldwell says. “We expect deflation in core goods prices to remain for the next two to three years as supply chains heal.”
One area of concern
And there’s one place of concern in the November CPI: core services inflation when you strip out shelter and healthcare. That measure has grown at a 7.5% pace over the last three months.
“Inflationary pressures could reflect relatively high inflation in these categories, which may be supported by continued strong wage growth,” Caldwell says.
In a recent speech, Fed Chair Jerome Powell has mentioned core services inflation excluding housing as potentially the “most important” for understanding the extent of future inflation.
Over the past 3 months, shelter excluding medical care declined at an annual rate of 1% primarily due to a glitch in the CPI methodology, according to Caldwell. This issue artificially accelerated CPI healthcare inflation earlier this year, he writes.
On balance, the November CPI report is likely a welcome one at the Fed.
A probable Fed move to slow the pace of interest-rate hikes this week “is reinforced by the favorable inflation reading we received today,” Caldwell says.
In Focused on the Fed part however, "we anticipate the Fed to step down to a 0.50% hike at tomorrow's meeting, from the 0.75% sized hikes completed in the 4 prior meetings. And another notch of moderation to a 0.25 percent increase in the February 2023 meeting now appears more probable.”
Inflation should slow considerably in 2023, and this will give the Fed room to cut rates before year-end, according to Caldwell.
