Inflation Is Not Dead After All. That’s Why the Fed Will Raise Rates Again.

Inflation, as measured by the Consumer Price Index (CPI), hit a high of 9.1% (annualized) in June 2022. Since then, the Fed made steady progress in reducing inflation until it was down to 3.0% in June 2023.

Economists and Fed fans were ready to pop the champagne corks to celebrate the Fed’s victory against inflation. The Fed’s target rate is 2.0%, so the 3.0% reading seemed just an inch away. Then a funny thing happened.

Inflation rose to 3.2% in July. Then it soared to 3.7% in August. We won’t have the September numbers until October 12, but they’re very likely to be higher again because the recent inflation has been driven by energy prices, and oil keeps going up.

Oil prices recently hit $91.00 per barrel, up from $67.00 per barrel as recently as June 27, a 36% spike in less than three months. Those wholesale price spikes have not worked their way through the supply chain yet, so it’s reasonable to expect further CPI increases based on gasoline prices in September and October.

In short, the Fed’s victory is in shambles, and they must now double down on rate hikes to get inflation back under control in time for the elections in 2024. As this article describes, it may be more difficult to do that than the Fed imagines.

The reason has to do with consumer expectations. So far, inflation has come from supply side disruption due to trade wars, the pandemic, and financial sanctions due to the War in Ukraine. That kind of inflation tends to control itself as consumers spend less on discretionary items to deal with higher prices on necessities.

The danger is that the inflation impetus jumps from the supply side to the demand side. At that point, consumers expect inflation across the board and accelerate purchases of all kinds to beat the anticipated price hikes. This happened in the late 1970s when supply side inflation (the Arab oil embargo) morphed into demand side inflation (runaway price increases in 1979-1981). We’re not quite there yet, but the danger is real.

Jay Powell knows this and will raise rates sometime this year (probably the November meeting, but not the meeting coming up this week) to keep things under control. Markets have not priced in another rate hike. Investor beware.

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