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Great news on inflation, but markets are getting ahead of themselves


August 11, 2023

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Once again, markets are taking the elevator while economic data takes the stairs. That is, it is good that markets initially reacted so well to the better-than-expected news on July’s Consumer Price Index (CPI) inflation number, and they may think that, because of such numbers, the Federal Reserve (Fed) is done with its interest rate campaign. However, the Fed had even better news on July, but they decided to increase the federal funds rate anyway. Furthermore, the picture for headline inflation going forward is not looking pretty, to say the least, as gasoline prices have increased considerably, and they have an outsized effect on inflation expectations.

According to the Federal Reserve Bank of Cleveland’s Inflation Nowcasting, headline inflation is expected to come in at 0.77% in August while its forecast for core inflation is expected to be 0.38%. If this is correct, it means that year-over-year inflation for August will go up to 3.81% from a 3.2% reading in July. The CPI release for August will come in on September 13, while the Federal Open Market Committee (FOMC) meeting is scheduled for September 19-20, at which time the FOMC will release its updated Summary of Economic Projections as well as its corresponding updated ‘dot-plot.’

We don’t want to be the market’s party poppers but if this information makes Fed officials decide to remain complacent regarding inflation, it is not going to look good on Federal Reserve FOMC members' curriculum vitae. And economists, including yours truly, have big egos, and they would not want to be remembered in the same vein as Fed members during the 1970s and early 1980s. Thus, we still believe that the Fed is going to go, at least, once more before the end of this year, which would put the current celebration in jeopardy once again.

The only caveat to our fed funds expectation, and forecast, other than an updated ‘dot plot,’ is that we need to see an important decoupling between headline inflation and core inflation. If core inflation continues to slow down due to a sizable slowdown in shelter costs, even if headline inflation increases on a year-earlier basis, then there is a possibility—very small—that Fed officials may consider risking not moving again. However, as it stands today, and considering that shelter costs have remained stronger than expected, we still believe that the Fed will increase the federal funds rate at least once more before the end of the year.

Below, we include our heatmap on monthly inflation to give an idea of what is needed for the Fed to achieve its 2.0% inflation target over the longer run, assuming different monthly rates of inflation. And if this table makes anything clear it is that the Fed’s work is not over.

U.S. employment growth, while slowing down, still shows strength

We have been waiting for U.S. employment growth to slow down considerably during the second half of the year. In June, we had a first sign that could be pointing to a slowdown in employment as the year was about to turn the corner into the second half. On August 4, we got another relatively weak employment number, this time for July, which is the first month of the second half of the year. It wasn’t as weak as we were looking for, but it still slowed down from the breakneck pace experienced during the first half of the year, while employment was revised lower, by 49,000 jobs, during the previous two months.

Still, employment growth during the first half of the year averaged 270,000 per month, a very strong performance. Some of this growth in employment shows sectors that are growing too fast while other sectors are just going back to ‘normal’ pre-COVID-19 pandemic levels and thus, these sectors still have some staying power.

As we have said in the past, one of the sectors that is growing too fast is government employment and especially state and local government employment. The reasons for this strong growth in state and local government employment are not very clear but could be related to the fact that many state and local governments were ‘priced out’ from hiring as the COVID-19 recession ended and workers started to bid wages and salaries higher. Today, there seems to be less competition from the private sector, so state and local governments are finding a more willing pool of workers to choose from. We saw strong government employment growth in June, up 57,000, mostly state and local government employment. However, July saw state employment dropping by 11,000 while local government employment continued on a hiring spree, adding 19,000 jobs in July while federal employment increased by 15,000. We continue to expect government employment to slow considerably during the second half of the year. The ‘other services sector,’ which is a much smaller employment sector, has also already created more jobs in 2023 than for the whole of 2019. Thus, this sector is not expected to add too many jobs going forward.

The education and health services sector has already created the same number of jobs during the first seven months of 2023 as was created for the whole of 2019, a ‘normal’ pre-pandemic year for job creation. Thus, we are expecting that sector to also slow down during the second half of the year.

The sectors that still have some staying power for job creation during the rest of 2023 according to our estimates are the leisure and hospitality sector, the professional and business services sector, the construction sector, the trade, transportation and utilities sector, the financial activities sector, and the information sector.


Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.

GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The

Index goes up when the U.S. dollar gains "strength" when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month.

ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023


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