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  • Alex Haseldine

No Rush to Cut Rates?

Ahead of the March FOMC meeting the much repeated mantra - from Fed officials and private sector pundits - is that easing too quickly and too soon would be much more risky than taking things slowly. That argument is partly based on fears that inflation pressure has stopped falling with actual inflation still clearly above target, partly on the the view that any re-acceleration in growth from here would risk a new round of wage inflation, and partly on fears that super-core inflation (services inflation ex shelter) is turning higher already.


Our favourite timely (rather than lagging) measure of underlying inflation pressure is the composite output price series from the PMIs. As shown below that has stabilised in recent months around the world, not just in the US. For the US, Europe and the UK it is now back within the pre-COVID range - figure 1. (the same is true more generally by the way).


Looking at the US specifically, we think that core inflation ex-shelter is probably the best (least misleading) measure of underlying inflation right now. Over the past 6 months it has been running around 1% per annum and is entirely consistent with signals from the PMI output price composite - figure 2 . The third chart shows why some people are still worried about super-core inflation, where wages are typically the main driver. But once you look under the hood it turns out that the recent upturn in super-core inflation is not a general wage pressure issue at all. It is essentially being driven by the very steep rise in auto insurance costs which have jumped by one third since mid-2022 - figure 4. Part of the jump in insurance premiums reflects higher repair costs for electric vehicles, where there is indeed a shortage of qualified mechanics. But most of all it reflects the decision by insurance companies to write off completely all electric vehicles involved in collisions (even minor ones) because of the risk that the battery and battery housing might have been damaged and so could lead to a vehicle fire. These are typical - and temporary - teething problems for a new technology and absolutely not a sign that wage pressures are reviving across the service sector as a whole. In fact, some companies are already stepping in to buy up written off EVs from the insurance companies because they have the expertise to check the battery and battery housings, and then resell the vehicles at a handsome profit. Eventually, that will probably lead to lower insurance costs, not higher ones.


Meanwhile, real time measures of rental inflation continue to point to lower shelter inflation going forward (figure 5) albeit that there is still a shortage of housing (new dwellings have run significantly below new household formation in recent years). Arguably, cutting rates sooner would help deal with this supply deficit more quickly, and in some respects might itself be disinflationary over the medium-term. in part by improving labour mobility.


Even so the Fed's default position (the least risky thing to do at this moment) is to go slowly, and to keep fighting the last war rather anticipating the next one. It would be no surprise, therefore, to see the median dot plot calling for just 2 rate cuts this year and no indications that QT is under immediate review.


Finally, there is another consideration that dare not speak its name – certainly in public speeches or the FOMC minutes , possibly not even in private discussions. If you take Donald Trumps latest riffs about what he would do if re-elected at face value, MAGA reads like an Orwellian disguise for dragging America back to the (inflationary) 1970s. 


As things his promises/threats include: punitive tariffs on imports, especially from China,  a war on immigration, throwing NATO and Ukraine under the bus, de facto ruling out any serious attempt at fiscal restraint or debt sustainability, effectively undermining the Fed’s independence in a not dissimilar fashion to his impact on the Supreme Court, taking a chain saw to environmental protections and incentives for clean energy, and potentially provoking China into a more extreme stance on US companies operating in China. 


Should the bond and stock markets conclude that his chances of re-election are pretty high, and that this time he will actually do what he threatens so loudly to do, we suspect they will both take fright. 


In short, conventional wisdom is that it would be risky for the Fed to rush into easing policy, for fear of re-stoking inflation, should the economy reaccelerate in response. It seems to us that the reverse is the case: it is potentially much more risky (and potentially inflationary) to delay than to start cutting rates soon.











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