With core CPI at 4% in November 2023, should the Fed target 3%?

On the eve of the Federal Reserve’s FOMC announcement, the US’s Bureau of Labor Statistics (BLS) released its much-awaited consumer price index (CPI) report.

November CPI moderated to 3.1% YoY from 3.2% YoY in the previous report, while remaining in sync with consensus expectations and registering its lowest reading since March 2021.

One of the primary drivers for the slowdown in inflation was the reduction in prices of energy commodities which have eased by 9.8% since November 2022, with gasoline, fuel oil, and piped gas declining by (-)8.9% YoY, (-)24.8% YoY, and (-)10.4% YoY, respectively.

As a whole, the energy category has eased (-)5.4% in the past twelve months.

The food category rose 2.9% YoY, with the ‘Food away from home’ component jumping 5.3% since the corresponding month last year.

A sharp uptick of 10.1% YoY was felt in the transportation services segment, rising from the already-elevated 9.2% YoY in the previous report, while shelter remained stubbornly high at 6.5% YoY in November 2023 following a moderation from 6.7% in the previous report.

The used cars and trucks component surprised markets by gaining 1.6% YoY, after registering five consecutive months of deflation. 

For the year, this index was down 3.8% YoY.

CPI MoM

On a monthly basis, CPI edged 0.1% higher, coming in above expectations that this measure would remain unchanged.

In October 2023, monthly CPI had fallen to 0%, moderating from 0.4% in the previous month, and decreasing from a 2023 high of 0.6% MoM in August.

However, experiencing an uptick of 0.4% MoM, shelter prices continued to exert pressure on household budgets, accelerating from 0.3% during the prior month.

In addition, food prices increased by 0.2% MoM compared to 0.3% MoM.

Core CPI

Non-food, non-energy CPI (or core CPI) eased to 4.0% in line with consensus expectations as published by analysts at TradingEconomics.com.

This metric remained unchanged since October 2023.

Deceleration was seen in the recreation category moderated to 2.5% YoY from 3.2% YoY along with the new vehicles index which slowed to 1.3% YoY as compared to 1.9% YoY in October 2023.

On a monthly basis, core CPI rose by 0.3%, edging higher than the 0.2% MoM registered in October 2023.

In particular, owners’ equivalent rent (OER) rose 0.5% MoM, leading to the shelter index being the most significant contributor to the core CPI MoM.

OER refers to the estimated rent that would be paid to change the status of an owned house to a rental property.

The Fed’s upcoming decision

With the Fed’s next rate announcement due tomorrow, the markets are widely expecting rates to hold steady at 5.25%-5.50%, even as the September 2023 dot plot projected one additional rate hike.

At the time of writing, data from the closely followed CME Fed Watch tool showed that expectations of the rate remaining unchanged are at 98.4% versus a 1.6% probability of an increase by a quarter percent.

The 3% argument

Despite the rhetoric around the soft landing, inflation is still twice that of the 2% target.

In an interview last week with CNBC Television, Mohammad El-Erian, noted economist and President of Queen’s College, Cambridge, stated,

There is a market romance right now with the softest of soft landings. I think that’s probably too much of a romance. My hope, as you know…is that the Fed targets 3% inflation, not 2% inflation, and that would allow us to soft-landing the economy…

As El-Erian states, an increase in the target rate to 3% would be highly beneficial for the Federal Reserve since the markets could be confident that rate hikes have reached their conclusion and a soft landing is close at hand.

However, in the present circumstances, such a move is unlikely, given the Fed’s unwavering commitment to the strict 2% inflation target.

Unlike several inflation-targeting regimes across the world, the Fed does not have the benefit of a flexible corridor to operate within.

As a result, even as economic realities and attitudes may evolve, the target likely does not have that same luxury.

With central banking effectiveness hinging on market credibility, a decision to shift away from the 2% target may well be perceived as a deviation from stated monetary policy, and an inability to bring down inflation to desired levels.

Even as markets expect the FOMC to cut rates in Q1 2024, Governor Powell indicated at a recent event that it is too early to ‘speculate when policy might ease.’

Tomorrow’s data releases shall also include the PPI which is unlikely to deviate much from market expectations given that the CPI was closely in line with projections.

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