[TOP STORY] US inflation expectations

Citadel’s Maarten Ackerman believes the Fed would be comfortable with inflation going back below 4% and staying there until it can start to support the economy again.

SIMON BROWN: I’m chatting now with Maarten Ackerman, chief economist and advisory partner at Citadel. Maarten, I appreciate the early morning. US inflation data came out yesterday afternoon. Consensus was for a rise in the headline inflation, a slight improvement in the core inflation. Both went higher than expected. This inflation story in the US is looking rough. My sense is that the Federal Reserve is looking perhaps more and more behind the curve?

MAARTEN ACKERMAN: Morning, Simon. Yes, you’re right. A monster number: 9.1% versus an expectation of 8.8%. Another 40-year high. But we need to keep in mind that this is history, looking back with these numbers, and I got the feeling that we are very close to the turning point. Nevertheless, it is a number that the Fed needs to be concerned about and they will continue hiking rates to address this. The market is already speculating whether the next move is going to be a full percent, and not another 25 basis points like we saw last time.

But if you look at some of the drivers of inflation and what’s been happening of late, I think the turning point is quite close.

Read: Hot inflation fuels bets on supersized Fed rate hike

SIMON BROWN: That’s a great point you make. I look at some of the drivers of it. Gas – which we would call petrol – in the data we are looking at for this period was a big driver of inflation, but that’s actually been coming down during July. The average is below $5. So, in a lot of sense, maybe if this isn’t the worst, we are very, very close to the top, because of course inflation … those big prints need to keep coming. And at some point it kind of solves itself.

MAARTEN ACKERMAN: Yes. If you think energy is up more than 40% over the last year, a lot of that came in the last bit since the [Russia-Ukraine] war started, gasoline up 60% – that’s for the year. But if you only look for the month, gasoline was up another 11% in a month; that’s a huge number. Now we know that recently the oil price started to slip; other food commodities as well. So that’s a positive sign – that will only show up in inflation numbers in months to follow.

But just think about it. Oil is currently sitting at about $100/barrel. If it stays around this level, [and] we get to February next year – because in February this year, when the war broke out, we went to $140 – that’s already a 30% decline in energy just from the base effect. So, for us to see another 40% increase in energy, oil needs to go to $200/barrel, $220/barrel, which is currently very unlikely.

We are already seeing energy coming down like I’ve mentioned; food commodities as well.

And then, as the base effect comes into the mix, I think next year inflation is going to decline quite sharply.

SIMON BROWN: Which means – and I know that suddenly last night there was talk of the markets pricing a 33% chance of a 1% rate increase when the Federal Open Monetary Committee meets in two weeks. That surely is not likely to happen. Probably another 0.75 because of that base effect, as you talk around. Almost certainly, the numbers are scary, but this is probably inflation peaking.

MAARTEN ACKERMAN: Yes. I think the Fed will take that into consideration, and probably stick to 75 basis points. If you look at inflation expectations [those are] also coming down; [they are] still high.

The Fed talks about getting inflation back to the target of, let’s say, 2%, 2.5%. They will start to take their foot off the accelerator when inflation starts moving into that direction, not only when it gets there.

So when we see inflation tipping over and starting to move lower, I think the Fed will take it a little bit slower, because obviously they want to keep the job market healthy and try to avoid an economic collapse – like they say, engineer a soft landing. That can very easily happen towards the end of this year, the beginning of next year, and that kind of move is going to be quite positive for sentiment and markets overall.

SIMON BROWN: And then, in that scenario – and let’s take that scenario where base effects start to play and inflation starts coming down –the Fed has done the increases, it’s not at that 2%, 2.5%, but it’s heading in that direction. We are suddenly in an environment where the conversation completely swings to when does the Fed start cutting rates?

MAARTEN ACKERMAN: …Although the Fed is not saying that, I think they will be comfortable with inflation going below 4% and staying below 4% to 3% for some time. They’ve wanted inflation – for two decades now – to address the debt levels. So it’s not only getting it back to 2.5%, but if they can manage it at a reasonable level, obviously much lower than the current high [9.1%], they will probably be comfortable with that. And you’re right, they could probably then start saying, well, we’ve done enough normalisation and we can start to support the economy and the job market again.

SIMON BROWN: Yes. So this is not the seventies, where things go crazy and out of control – and no one seemed in the seventies to be in control for a long time.

Maarten Ackerman, chief economist and advisory partner at Citadel, I appreciate the early morning.

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