Inflation Moderates More, But How Will the Fed React?

There was some moderate good news on the inflation front, with seasonally adjusted overall inflation up 0.1% month over month in November. Significantly better than October’s 0.4%. Without seasonal adjustment, the year-over-year view was 7.1%.

Slowing inflation is certainly better, although as Nancy Davis, founder of Quadratic Capital Management and portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund, said in an emailed note, “While Tuesday’s report showed a deceleration in inflation, which is great news, inflation is still very elevated and is over three times greater than the Fed’s 2% target, so this isn’t time for the Fed to take a victory lap.”

Also, “Tuesday’s number won’t likely change anything for the Federal Reserve ahead of its meeting this week, as its decision was likely made weeks ago. Powell wants to show the market that the days of the big, 75 basis point hikes are over and the pace is slowing, so it’s likely that the Fed announces a smaller 50 basis point rate hike on Wednesday.”

To be clear, Davis’s point isn’t that the CPI numbers didn’t suddenly turn the heads of Powell and others in the Fed and point them to a kinder and gentler economy. Instead, the plans were publicly firming in early November, as a Fed release stated, “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

There had been growing criticism from without, and signs of some from within, that there were too many large rate hikes that, as all Fed rate increases do, take months to fully have their effect felt by the economy. Powell and all likely did not want a repeat of 2018, with three now seemingly tiny 25 basis point increases with dour market responses, followed by multiple decreases in 2019.

For CRE, the prospects of slowing inflation would eventually be interest rates that might again drop. But a 50-basis point increase is still a significant hike and means even higher financing costs in the immediate future. To get real changes in monetary direction will require clear and ongoing improvements in inflation.

“While it is certainly possible that we have now passed peak inflation, if we keep up this pace of decline, price increases will continue at levels that are still very painful for consumers,” Davis wrote.

The Fed’s likely reaction would then mean higher interest rates for longer, which would be very painful for those in commercial real estate.