Inflation: Economy ‘too resilient’ for Fed to cut rates, strategist says

August's Consumer Price Index (CPI) report displayed rising inflation month-over-month and year-over-year, pointing to energy and gas prices as key cost drivers. Newton Investment Management CIO and Head of Equity John Porter reviews the inflation data and how it stacks up against the Fed's inflation rate target and possible interest rate plans.

"The work's done in raising rates," Porter says, adding: "The Fed and everyone else is waiting to see the ultimate impact of the aggressive tightening that they've been on over the past 18 months."

This post was written by Luke Carberry Mogan.

Video transcript

AKIKO FUJITA: Its August consumer price index report showed a bigger than expected jump in inflation last month, with headline prices rising 0.6% month on month and 3.7% on an annual basis.

Joining us to break things down is John Porter, Newton Investment Management chief investment officer and head of equity.

Good to talk to you today.

Let's start with that data, because when you think about the increase that we saw, a lot of that was driven by energy prices.

How big of a concern, if you're the Fed, is this about re-acceleration, how sustainable these higher prices could be?

JOHN PORTER: Well, I think it's a mixed picture, because I think most of the longer term focus of the Fed is on the core CPI number, which is obviously going to exclude energy, but you can't ignore the fact of the rise in energy prices and the likely impact on crimping consumer spending.

Being honest, the Fed probably doesn't mind seeing energy prices up a little bit, and they wouldn't mind seeing consumer spending slow down a little bit, and to the extent that prices of the pump impact consumer behavior, it might help the Fed towards their chosen agenda.

SEANA SMITH: So, John, do you think the market's then reading this right?

Because when you take a look at the Fed fund futures here, traders still pricing in little chance here of a hike next week, and then about a 50% chance of a hike later this year in November.

JOHN PORTER: I think most of the Fed's work is done clearly.

I think that the market is probably about right in pricing a 50% chance that there's another 25 to 50 basis points hike between now and in year end, but the work's done in raising rates.

What needs to be done now is to wait and see the resulting impact of the tightening.

There's always a lagged effect.

We all recognize that.

Maybe it's been a little bit more of a lag this time than many expected, but I think the Fed and everyone else is waiting to see the ultimate impact of the aggressive tightening that they've been on over the past 18 months.

AKIKO FUJITA: So, John, with that said, I mean, how do we look at the inflation print that we got today?

I mean, we've got another meeting coming up this month.

No real change expected in policy there, but to your point, it is core CPI, or more importantly PCE, that the Fed looks at.

Does the data that we got today change your base case at all in terms of where the Fed goes?

JOHN PORTER: Well, just to share what my base case is, I think any kind of Fed cut is not in the cards for the next 12 to 18 months.

I think the economy remains too resilient, too strong for the Fed to be thinking about cutting any time soon.

We have to remember, if you look at CPI as their target, core CPI as a measure of their target, core CPI has gone from about six and a half year ago to 4.3, so 200, 225, 230 basis points of improvement.

The Fed has at least another 230 basis points of improvement that they want to see before they can begin to contemplate cuts, so I just don't think that's going to happen in the next 12 or 18 months absent the economy really hitting a wall, which nobody would like to see.

SEANA SMITH: John, what do you think the road ahead for inflation looks like?

Because, yes, it did seem like we were making some progress, but just later this week, we had the looming UAW strike.

We also have the recent contracts that we've seen in a couple of sectors, including what we've seen in the airline space and the healthcare industry.

Do you see that at all potentially putting some upward pressure here on prices in the short term?

JOHN PORTER: I'm not sure about upward pressure, Seana, but I think it reduces the downward pressure.

Your question went right to where I would have started, which is the UAW, which is certainly in the headlines that everyone's focused on.

But I think it is reflective of wage inflation, which is such a critical issue in looking at the broader inflation picture.

It's persistent, and I think it's going to be part of the reason why getting inflation down to the 2% target and seeing it stay there for a sustained period of time is going to be an elusive goal.