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January 2024

The Fed:
Deflation Continues, but it will be
a Bumpy Ride

Paul Single Managing Director

Key Points

    • Inflation is falling and getting close to the Fed’s target of 2%.
    • Getting from roughly 3% to 2% inflation is the hardest part of the inflation battle.
    • The Fed plans on maintaining restrictive monetary policy until they are assured that inflation will be sustainable at 2%.

    The policymakers at the Federal Reserve Bank are in a very difficult position. The important debate at the Fed centers on how long it will take for inflation to get to a level they are comfortable with so that they can begin to lower short-term interest rates. Those rates are too high to sustain economic growth over the long run. So, the timing of this interest rate cut is a challenging task. Cut too early and inflation may pick back up; cut too late and economic growth may slow more than desired. 

    The Fed has completed about 80% of its goal: Inflation, as measured by the Consumer Price Index, has fallen from a recent peak of 9.1% in June 2022 to the 3.4%  in the recent reading from December 2023. Their goal is a sustainable rate of 2.0%. Economic goals are the same as many other goals in life — the last mile is always the hardest. 

    Inflationary pressures have fallen mainly due to the “goods” portion. In the past year, goods inflation has increased by just 0.7% , which is a big change from the pandemic days when the yearly change hit a peak of 14.1%. Back then, there was strong demand for household items such as big-screen TVs, furniture and exercise equipment. Demand was limited due to COVID-19-related cutbacks in production and snarled transportation logistics. There is now a balance of supply and demand for goods, and that has brought the prices movement back near the level it was before the pandemic (Chart 1).

    Chart 1: CPI: Goods and Services
    % change, year-over-year, seasonally adjusted

    Source: Bureau of Labor Statistics, as of December 2023.

    Information is subject to change and is not a guarantee of future results.


    “Service” inflation is much stickier — prices do not fall as quickly when demand tapers off. Service inflation is controlled mostly by housing costs and services that tend to be labor intensive. Housing costs and wage gains are not falling quickly, so service inflation remains elevated. 

    This has many of the Fed’s policymakers revealing that they are in no hurry to lower interest rates. They plan to maintain a restrictive policy stance until inflation is moving down sustainably toward 2.0%. We expect that will not happen until the second half of this year. We expect two to three cuts of 25 basis points this year, which is close to what the Fed plans, but not nearly as severe as current market expectations, which plan on five cuts (Chart 2).

    Chart 2: Federal Funds Rate: 2024 Year End Forecast (%)

    Sources: Federal Reserve; Bloomberg World Interest Rate Probabilities (WIRP) page; CNR Research, as of January 23, 2024.

    Information is subject to change and is not a guarantee of future results.


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