MNI INTERVIEW: CPI Could Bring Forward Fed Pause - Ex-Staffer

The fairly broad-based slowing in inflation revealed in the November CPI report could prompt the Federal Reserve to pause its interest rate increases earlier than previously thought, former Fed staffer Riccardo Trezzi told MNI.

While the November consumer price figures do not affect the expectation of a 50bp rate increase at tomorrow's FOMC meeting, the softening could mean the Fed pauses in March after one more hike in the cycle at the January/February meeting, said Trezzi, a former senior economist at the Fed Board.

"I think they will be done raising rates by January basically and then they will pause there for five to six months," he said. "They will just deliver what they promised and then pause."

On a month-to-month basis, the consumer price index rose just 0.1% in November, down from 0.4% in October, and core CPI rose 0.2% on the month, down from 0.3% the prior month. But core inflation ex-shelter, a measure Fed Chair Jay Powell highlighted recently in a speech, has been negative month-over-month for the past two months, down 0.13% in November.

Ex-officials have anticipated the Fed could signal a peak rate reaching about 5%, but reduced price pressures may leave the Fed peaking under that, Trezzi said. (See: MNI: FOMC To Signal Path To 5% Next Year - Ex-Fed Officials)

The FOMC could still deliver a relatively hawkish signal in the Summary of Economic Projections as Fed staff might not have time to adjust forecasts to include the new CPI report, he said.

But the fresh inflation data raises odds the central bank could adjust its interest rate guidance in the FOMC statement. In November, the Fed said it anticipated "ongoing increases" in the fed funds rate to reach a sufficiently restrictive stance to see inflation on track to reach 2%.

"What can happen is they will go for the slightly more dovish option," Trezzi said about the statement. "After today there is a concrete chance."

ODDS OF '23 CUTS

Slowing inflation will also allow the Federal Reserve to cut interest rates next year. "There's now a very high chance that the FOMC will start cutting around June 2023," said Trezzi who used to brief Fed officials and contributed to the staff forecast.

"In this environment, the moment in which they will have some indications that rents are turning is also the moment in which the FOMC will pivot," he said, taking note of spot rent measures that have have already turned and adding he expects CPI rents could turn early in the second half of next year.

"Maybe they will not need to keep the federal funds rates at 5%, 5.25%, or even 5.5% for the entire 2023. Maybe they try to be more gentle because at some point that will also shift their focus back to the labor market," he said. "Essentially, this is what the CPI report implies."

Noting the medium term inflation outlook is still not in the Fed's favor and that CPI rents are running almost 10% month over month annualized, Trezzi said his models project core PCE at around 3.5% by year-end 2023, while remaining significantly above target through 2025 at around 2.8%.

But Trezzi said the risks to the model forecasts are probably now to the downside by several tenths of a percentage point.

"The very good news is the fact that goods are in deflation and services excluding rents have already moderated significantly," he said. "I do not expect the Fed to pivot at this meeting. But the tone will be different after this couple of reports."