Opinion: Opinion: Annual inflation was not 7.1% in November; it was 3.7%

The Federal Reserve should declare an immediate ceasefire in its war on inflation and keep its benchmark rate stable instead of increasing federal funds by half a percentage point to a range of 4.25% to 4.50% , as expected at the meeting that ends Wednesday .

With the relatively benign November consumer price index report released Tuesday, the Fed now has “convincing evidence” that it has achieved its immediate goal of a significant slowdown in inflation.

The CPI was better than expected in November, with headline inflation rising only 0.1% (1.2% yoy) and core inflation rising 0.2% (2.4% yoy).

Read: Inflation is slowing, but the battle is far from over

The US stock exchange SPX,


on Tuesday, the CPI report was initially hailed as confirmation that the Fed could begin to cut, but by noon the realization dawned that the Fed will continue to raise interest rates.

Market Snapshot: Dow clinging to gains in last hour of trading as Wall Street gauges cooler inflation report, Fed’s next interest rate decision

Better than the media says

The CPI report was actually better than it is portrayed by the media, which continues to irrationally focus on year-over-year changes in inflation rather than looking at what has happened since the Fed started nine months ago. raising interest rates. For example, what should we talk about. this incoherent headline in the New York Times: “US inflation cools as consumer prices rise 7.1 percent”?

If we don’t want to miss the turning points, we need to shorten our horizon to just under a year, but not so short that it’s all noise and no signal. Three months is about right.

In March 2022, when the Fed raised rates for the first time, inflation accelerated. From January to March, the CPI was up 11.3% annually. That was an alarming inflation rate that demanded action from the Fed.

But then the Fed raised rates in six consecutive meetings, from near zero to nearly 4%, and now inflation is slowing. From September to November, inflation increased by 3.7% year on year.

That’s a significant advance in the most relevant measure of inflation.

Read: Why November’s CPI data is seen as a game-changer for financial markets

The wrong perspective

The progress is much less clear when the figures are reported on an annual basis, as most media outlets do. From November 2021 to November 2022, inflation rose by 7.1% — but that figure has no significance to our understanding of what the Fed achieved, because that time frame also includes five months of high inflation before the Fed intervened.

Since interest rate hikes take some time to have an impact on prices and the economy, they didn’t really start to bite until July. In the five months since, inflation has slowed to 2.5% year on year, which is noticeable to anyone watching. The unprecedented rise in interest rates is working to cool price increases.

The progress is even greater when you consider that almost all of the inflation we’ve been suffering lately has come from higher rents, which are now rising at an annual rate of 10% in a delayed response to last year’s incredible increase of more than 20% house prices and tight rental markets.

Rents are still rising while house prices are falling

Home prices have now started to fall in most regions of the US. Rents for new tenants have also started to fall, but rents paid by existing tenants have lagged and could last another year or more, according to research by Goldman economists. Sachs. That’s because rents on existing leases tend to reset annually.

Rental prices are used to calculate the costs not only of tenants, but also of homeowners. It’s like we measured champagne prices by looking at how much beer costs.

With more than 900,000 multi-family homes under construction, supply constraints will soon begin to ease, easing pressure on rents when those units come on the market, likely in the next year or so.

Rents have an excessive impact on the CPI because rents are used to calculate the costs not only of tenants but also of homeowners. It’s like we measured champagne prices by looking at how much beer costs. Yes, there is usually a correlation, but not always.

Using rents to measure homeowners’ costs may be an acceptable method in normal times, but not now. Based on the increase in rents, the CPI showed that housing costs for homeowners rose 8% year-over-year in November. Nobody believes that to be true. Most homeowners have fixed-rate mortgages, so principals and interest payments have not increased.

The right perspective

The best thing to do in this situation is to recognize that we need to exclude the cost of lodging (which makes up a third of the CPI) if we want to see where underlying inflation is headed.

“Significant disagreement over the proper way to measure lodging inflation argues for looking at inflation measures that place less weight on lodging inflation, and no more, when the decision is more important,” Goldman Sachs economists wrote. Ronnie Walker and David Mericle in a note published in October.

The CPI excluding lodging fell 0.2% in November and is up just 1.3% year-on-year over the past three months.

Even Fed Chairman Jerome Powell has admitted that a sudden drop in home prices won’t show up in the CPI for months, but he doesn’t act like he believes it at all. If he did, he would urge his colleagues at the Fed to pause now and let the full 375 basis point impact of the tightening on the economy work.

More: The Fed slowed to a quarter-point increase in February after a weak reading of consumer price inflation

However, we know that the Fed will not pause. The Fed lost too much credibility last year when it missed the rapid rise in inflation as the economy emerged from the pandemic lockdown, and now the Fed is trying to restore public confidence as an inflation fighter.

Unfortunately, that makes a recession almost inevitable, because the Fed is going to do what it always does: raise rates too far and push the economy into a job-killing recession.

Rex Nutting is a columnist for MarketWatch and has written about the Fed and the economy for over 25 years.

Rex Nutting on inflation

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Everyone is looking at the CPI through the wrong lens. By the best measure, inflation has fallen to the Fed’s target over the past three months.

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