Declining energy prices gave the Federal Reserve a reason to pause rate hikes this month. May consumer prices for all items, not seasonally adjusted, came in at a moderating 4%. Almost all this moderation can be attributed to declining energy prices. Food increased by 6.7% and all items excluding food and energy increased by 5.3% compared to a year ago. Energy declined by -11.7%, which is great for disposable income.
Nonetheless, inflation with the volatile food and energy categories removed is declining slowly. This makes it difficult to know exactly how restrictive Fed policy really is. The Fed has chosen to keep the Fed Funds Rate between 5% and 5.25%. Consumer prices without food and energy were still at 5.33% in May. Using that measure as a gauge, Fed policy is neutral at best. Below is a comparison of annual inflation without food and energy to energy prices over the last five years. Obviously, energy shows a low correlation with consumer prices ex-food and energy.
What I do not know, and what the Fed doesn’t know, is how much current rates are impacting bank lending. The amount of money available to lend may be slowing the economy more than we know from looking at other indicators. We will probably know by the end of next month.
We may be seeing a further disconnect between the US economy and the rest of the world. The European Central Bank increased rates for the eighth time this week. The Bank of Canada hiked rates last week and so did the Reserve Bank of Australia, only a few months after anticipating a pause.
I shall discuss what this means for markets in a future blog and in our monthly newsletter.
* CPI Home : U.S. Bureau of Labor Statistics (bls.gov). U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Energy in U.S. City Average [CPIENGSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIENGSL, June 15, 2023. 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, June 15, 2023.