Why Interest Rates Will Soon Be Falling

Over the past several months, this blog has emphasized that the war on inflation has been won. In measurement terms, the “go to” index for the public and the Fed is the CPI (Consumer Price Index), and the crucial monthly number is the 12-month look-back, i.e., the rate of inflation as measured over the past year (+3.3% as of July). The three-month and six-month trends aren’t ever discussed (the three-month trend is +1.9% annual rate; the six-month is 2.6%). In addition, as we have emphasized in these blogs, BLS’s imputation of shelter costs (30% weight in the CPI) uses data that is lagged 8-12 months. If current data were used, CPI would already be significantly under the Fed’s CPI 2% target.

Markets are finally coming around to this viewpoint. The graph at the top shows that the Fed’s rhetoric has the market believing that the current Fed Funds rate (5.25%-5.50%) will be with us for the rest of the calendar year, but you can see that there is some relief in 2024. This is from the point of view of a market sold on a “soft-landing.” If Recession were the base case, the downtrend in rates would be much faster.