Inflation slows again, pointing to another rate pause

REAL ECONOMY BLOG | November 30, 2023

Authored by RSM US LLP

Inflation in October fell to its slowest pace in more than a year, solidifying the case for the Federal Reserve to hold rates steady at its next meeting in two weeks.

The personal consumption expenditures price index, the Federal Reserve’s favorite inflation metric, was unchanged on the month, while the core measure rose by 0.2%—lower than expected.

On a year-ago basis, the index fell to 3.0% while core inflation was at 3.5%.

The data came as a pleasant surprise for both the Fed and the market, which has been increasingly betting on the Fed to begin cutting its policy rate next year.

Consumers remained resilient. While personal spending came in as predicted at 0.2%, lower inflation data helped increase spending volume more than anticipated, at 0.2% on a monthly basis.

This was only slightly lower than September’s figure of 0.3%, which was revised lower following the release.

Lower inflation and solid spending numbers are the recipe for a soft landing, which seems more likely than ever. This is the reason why we have revised our recession probability downward from 60% earlier this year to 25%.

When we look back at our estimate of the Phillips curve and the sacrifice ratio between inflation and the unemployment rate, the economy has been performing much better than our baseline scenario.

To bring inflation down to 3%, the economy was initially expected to have a 5% unemployment rate. On a three-month moving average annualized basis, inflation is now 3.2%, while the unemployment rate stands at 3.9%. This means the economy is on track to meet or even beat our more favorable scenario, where reaching 3% inflation would require an unemployment rate of 4.4%.

One of the main drivers of this achievement has been a sharp revision to excess savings, which turned out to be much higher than believed.

The savings rate in October picked up slightly to 3.8% but remained significantly lower than earlier this year, indicating that consumers continue to be on solid financial footing, spending down their income and savings.

Income was also a significant factor, posting a solid 0.2% increase on the month. On top of that, inflation-adjusted disposable income grew in October for the first time in five months, which only bolsters the case for a soft landing.

The takeaway

Given Thursday’s data, we are more confident that the Fed is finished with hiking rates in this cycle. The Fed’s key gauge for underlying inflation, the super core services less energy and housing, fell to 2.66% on a three-month moving average annualized pace.

We believe it is time for the Fed to signal a shift toward a more balanced approach in its next meeting, including considerations of rate cuts next year.