Does the Fed’s ‘final 5-pound’ issue with inflation point to gradual rate cuts?

“Focus is back on the inflation front in markets this week, and the release of the November Consumer Price Index (CPI) is expected to show price increases continued to make little progress toward the Federal Reserve’s 2% goal.

Wall Street economists expect headline inflation rose 2.7% annually in November, an increase from 2.6% in October.
On a “core” basis, which strips out food and energy prices, CPI is expected to have risen 3.3% over last year in November. This would mark the fourth straight month of a 3.3% reading of core CPI.

Zoom out to mid-2022 with CPI’s 9% peak, and the “significant progress” is clear, as Fed Chair Jerome Powell has reminded us.

But look closer at the past few months and the Fed appears to have an issue many of us have experienced before.

While some have likened the final fall in inflation to the struggles of the “last mile” in a race, ADP chief economist Nela Richardson told Yahoo Finance the Fed’s current predicament is akin to a weight-loss journey.

“The labor market is slowing. Wage growth looks like it’s plateauing, and the Fed is still trying to get inflation down,” Richardson said. “So I liken that to trying to lose the last five pounds; it’s usually the hardest, and getting from two and a half percentage points of inflation back to 2%, it’s probably going to be the trickiest part.”

As is often the case when looking to see a nice flat number on the bathroom scale, achieving the number can come with costs. In the case of weight loss, maybe some final, ill-advised, and extreme measure to hit that 180-pound goal takes some muscle gains away with it. In the case of the Fed, it may be keeping rates “higher for longer.”

For instance, Richardson points to wage growth, which she admits “probably does need to come down to be consistent with 2% inflation.” But, she added, the timing matters. ADP’s private wage growth data shows workers’ wage gains are “barely keeping up” with CPI.

If a strong “higher for longer” stance on rates from the Fed rapidly drove down wage gains and weakened other areas of the labor market, things could unravel quickly. If consumers can’t keep up in terms of wages and prices, Richardson said, then “it’s going to be difficult for them to keep spending at the rates that they are right now, which is really bolstering the economy.”

This pushes Richardson (and other economists) to favor a gradual interest rate-cutting approach from the Fed over the next year. It’s like a trainer’s advice to stay on a good diet that’s been working. The number on the scale will likely come eventually; it’s not worth risking sustainable health with something more extreme, like eliminating carbs in perpetuity or hitting an 86-hour water fast.”