Inflation News: Cooler Report Opens Door to Interest-Rate Cuts in 2024

Ivanna Hampton: Lower than expected numbers show, inflation is cooling. The Labor Department reported some consumer prices like gas and airfares declined in October. That’s lifting hopes that the Federal Reserve is done with raising interest rates. Morningstar Research Services Senior U.S. Economist Preston Caldwell has reviewed the report, and he’s here to talk about it. Thanks for being here, Preston.

Preston Caldwell: Thanks for having me, Ivanna.

Hampton: What trends stood out to you as inflation appears to loosen his grip on the economy?

Caldwell: I would say that core inflation, first off, is holding about steady. Core inflation strips out volatile food and energy prices, and so, we did see markets react very positively to the fact that core inflation was 0.2% month-over-month in October compared to expectations of 0.3%. But from our vantage point, the three-month annualized growth rate in core inflation has been consistent in the 3% area—it was 3.4% annualized in October, a small uptick from 3.1% a month ago. And that small uptick is driven largely by an uptick in healthcare inflation, which actually won’t replicate in the PCE index, which is a separate inflation index, which will be released later this month and is the main one we focus on.

So all that’s to say that core inflation is holding steady at fairly low levels, not quite back to the Fed’s 2% target. Shelter’s the main component to core inflation—that still remains high. But we think a drop in shelter inflation is around the corner.

Hampton: Now, Fed Chair Jerome Powell has recently said inflation has given them “a few head fakes.” Did you see any potential head fakes in today’s report?

Caldwell: Yeah, it’s a good question. What I would say is, again, we had one month where inflation was quite low, almost back to the Fed’s 2% target. But we want to see additional months of that playing out in the data. One thing that’s bringing inflation down right now is durables prices, which are actually deflating, prices are falling. So there’s concern that that might not repeat in the future by the Fed, and if that ceases, that could cause the overall inflation rate to rise. I happen to think that durables prices will continue deflating because of supply chain relief, but the Fed will want to see that play out in the data. And importantly, it will want to focus on the least volatile components of inflation, sometimes called super core inflation, which is, we could say, core services excluding housing. And that component of inflation still has yet to come down to 2%. In terms of the PCE index, that super core inflation is still running at about 4% year over year.

And so in order to bring that down, we’ll probably have to see further cooling off of the labor market as well as further just general dissipation of inflation momentum. So that’s one thing the Fed will be keying in on, and I will as well.

Hampton: All right. And Morningstar believes that interest-rate hikes are over. The Fed is scheduled to unveil their next interest-rate decision in December. What else should investors watch for that will support holding rates steady?

Caldwell: Well, I think they’ve gotten enough evidence already, really, barring any disastrous news. I would say that they’re going to hold steady in December, not high rates. The question really turns to when could they start cutting rates. I would say today’s report, in conjunction with the news of recent months in terms of inflation and other data points, suggest that we will see the Fed cut at some point in 2024. I still think as early as March because I believe that inflation will be back to the Fed’s 2% target in the first quarter of 2024, and also GDP growth will substantially weaken in that first quarter and that will induce the Fed to do one cut in March and then another cut in June and every meeting after that. But regardless of the exact timing, I do think we have aggressive cutting from the Fed in store in the second half of 2024 throughout 2025 in response to normalizing inflation and weakening growth. And that will be needed to sustain a rebound in GDP growth.

Hampton: Thanks, Preston, for your insights into today’s inflation report.

Caldwell: Thanks for having me, Ivanna.

Watch “Fed Focused on Higher for Longer, But Rate Cut Talk Likely Coming” from Preston Caldwell.