MNI INTERVIEW: June CPI Seals The Deal For Sept Fed Cut-Tilley

The latest round of good news on inflation should give Federal Reserve officials the confidence they need to begin cutting interest rates in September, former Philadelphia Fed economic adviser Luke Tilley told MNI.

Policymakers have probably fallen a little bit behind the curve on cuts and should start cutting in July, Tilley said in an interview. They will, however, hold off in order not to spook investors after they've effectively signaled that the July FOMC is off the table with their June Summary of Economic Projections.

The June CPI data "should be enough to restore the Fed’s confidence that inflation will be returning back to 2%. When you take it all together it looks to us like inflation is slowing and the first quarter spike was a bit of a head fake,” said Tilley, now chief economist at Wilmington Trust.

CPI inflation fell unexpectedly in June to 3.3% in a report that showed benign signs of broadly easing price pressures. Rent and owners’ equivalent rent both increased 0.3%, the smallest gain since August 2021.

HELTER SHELTER

“The most important part of the report is if you just take the entire CPI and take out the shelter component it’s really been running at or below the Fed’s target for about a year,” Tilley said. (See MNI INTERVIEW: Fed Might Need Bigger Cuts If It Waits Too Long)

Now that shelter costs finally appear to be letting off, he said, this should give Fed policymakers greater comfort that inflation is heading sustainably back to target, while a weakening job market and softer consumption suggest little prospect of any resurgence in prices ahead.

“Powell said an unexpected weakening of the labor market would be another reason to cut. It’s kind of happening right now and the labor market is a trailing indicator,” he said. “If you wait for weak labor market data the horse is already out the barn.”

WEAKER JOBS

Tilley pointed to a range of indicators, including weaker payroll growth, a rising unemployment rate that already almost matches the Fed’s expectation for peak unemployment, and a spike in the number of unemployed persons, as signs of a job market that is starting to fray.

“The median (Fed) unemployment rate forecast is 4.0% at the end of the year, we're already at 4.1% – by definition half of them are probably too low. I think that they're too optimistic with the labor market forecast,” he said.

“They probably are wringing their hands a little bit, maybe they would want to start cutting in July. But I don't think there's an economic difference, and the risk is too large that you spook markets," he said. "There’s always this element of ‘what do they know that we don’t know?’”

Tilley still thinks the economy is heading for a soft landing, and sees GDP growing 2% this year. Nonetheless, there is about a 30% chance the country could slip into recession, he said.