Inflation Outlook Isn’t that Bad, Ditto Rate Hikes

Even with core CPI the highest in 10 years, the number shouldn’t ‘spook’ the Fed, says Pantheon’s Shepherdson.

The recent inflation numbers are higher than usual, but don’t suggest any surge ahead, according to Ian Shepherdson, chief economist at Pantheon Macroeconomics. The Consumer Price Index reading for July, stripping out volatile food and energy costs, showed a 0.2% increase, which translates to 2.4% year over year.

That’s the highest since September 2008 for this so-called core inflation, right before the financial crisis sent inflation and interest rates tumbling. But Shepherdson cautioned in a research note that the latest trailing 12-month number looked high only because a year ago it was low. Unnaturally low.

Expect to see the core CPI in the range of 2.3% to 2.4% for the rest of the year, he contended. And the Federal Reserve, Shepherdson wrote, “won’t be unduly spooked by the apparent surge in core inflation.”

The Fed is expected to hike short-term interest rates two more times this year, and three in 2019. That would increase the federal funds rate to 3.13% by the end of next year.

The fed funds rate has historically been 1.3 percentage points above headline CPI (with energy and food included), CFRA says. For the 12 months through July, the headline figure was 2.9%. So the Fed’s benchmark is still far below this inflation measure.

Action Economics forecasts that the 10-year Treasury will yield 3.5% by August 2019 and the two-year 3.35%, meaning there won’t be an inverted yield curve—a condition that’s a sure signal of an impending recession. When there’s an inverted curve, the two-year yields more than the 10-year. Right now, the 10-year note is hovering just under 2.9% yearly, with the two-year at 2.6%.

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