Sorry, But We’re All Out of Deflation Today

A big disappointment in August CPI, with gasoline the only significant deflationary component. Markets now fully expect a 75 bp hike at the September FOMC and have raised the expected cycle-peak funds rate to 4.3% at the March 2023 meeting. Strength in the trade-weighted dollar since the data release implies that markets are more worried about a hawkish shift in Fed policy than they are about inflation. Despite the disappointment, headline CPI on a year-on-year basis peaked in June and has fallen for two months sequentially, including August. Core peaked in March and fell for four months sequentially, with August being the only month in which it rose. This is consistent with the 13-month lag in our monetarist model, reflecting that the steep decline in M2 growth began to sharply decelerate exactly 13 months ago. In the death race between receding inflation and the contractionary costs of an unnecessary Fed hiking cycle, the gift of time has just been diminished by one month.