The Door Is Wide Open To Multiple Fed Rate Cuts

Nuthawut Somsuk The evidence supporting multiple Fed rate cuts is now solid. As I’ve been documenting for at least the past year, shelter costs, as calculated according to the BLS’s flawed methodology, have been artificially raising reported CPI inflation. Abstracting from shelter costs, the year-over-year change in the CPI has been less than 2% for 10 of the past 13 months, and in June, it was 1.8%. This clearly meets and exceeds the bar that Powell set this week, thus opening the door to multiple Fed rate cuts that could begin as early as the July ’24 FOMC meeting, and will almost certainly occur at the September 18th meeting and at subsequent meetings. I’m thinking multiple cuts, more than the 2½ cuts that are now priced to occur by the end of this year. Chart #1 is the one that cements the case for multiple rate cuts. Owners’ equivalent rent makes up about one-third of the CPI index, and as the chart shows, this has been adding significantly to the rise in the CPI index until this month. The annualized rate of change in this index for the month of June was 3.37%, which is the lowest rate we have seen April ’21. I’ve shown Chart #2 repeatedly for the past year or so. The relationship between the year-over-year change in Owners Equivalent Rent and the year-over-year change in housing prices continues: 18-month-old housing price changes effectively determine today’s shelter costs, according to the BLS methodology. The only good news here is that the deceleration in housing prices which began two years ago dictates that the OER component of the CPI will continue to decelerate at least through October of this year. Chart #3 compares the year-over-year change in the CPI to the same change in the CPI ex-shelter. Note that two typically move together, but over the past year, there has been a substantial difference between them. That gap, which has persisted for over one year, is completely explained by the OER (shelter) component. Absent shelter costs, the year-over-year change in the CPI has been less than 2% for 10 of the past 13 months, and it fell to 1.8% in June. The overall CPI is very likely to close the gap by moving lower as shelter inflation continues to decline. Chart #4 compares the year-over-year change in the CPI ex-energy (which I have chosen mainly because it is a more stable index and thus provides an easier comparison to interest rates) and the level of 5-yr Treasury yields. Treasury yields tend to track inflation, but with a lag that can approach one year or so. With the CPI ex-shelter now down to 1.8% (see the green asterisk in the lower right-hand corner of the chart), we might reasonably expect Treasury yields to move substantially lower over the next year or so. In sum, the Fed has no reason to not lower rates soon. The market fully expects the first rate cut to come at the September FOMC meeting, and another 1½ cuts to come by year-end. I don’t see why the Fed can’t move sooner and more forcefully. Inflation has been licked, and interest rate-sensitive sectors of the economy are really hurting. Lower rates would provide welcome relief, and it would take a whole lot of cuts to add up to any meaningful stimulus. Cutting rates now would not be playing politics, since it would not boost the economy by any reasonable measure before the November elections; it would instead be a responsible move to avoid further damage to the economy. Original Post Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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