Why is the Fed still so cautious about interest rates?

Despite the CPI coming in unexpectedly low, the Federal Reserve needs more convincing that inflation is really getting better.

The other shoe dropped on inflation Thursday. After the consumer price index came in unexpectedly low Wednesday — up 3.3% year over year for May — the producer price index rose 2.2% for that same period. That was also less than expected. PPI fell 0.2% month to month. 

In between those two data releases, the central bank’s Federal Open Market Committee finished its June meeting, announced new interest-rate projections and held a press conference. Which, in spite of that inflation-is-getting-better CPI report, sounded pretty cautious.

The consensus among the Federal Reserve governors is to cut interest rates once this year, versus three projected cuts when the Fed last announced predictions in March. 

Where’s all this going? First, some producer price index 101. 

The PPI for final demand, as the report is officially called, measures the prices producers receive for the goods and services they sell — appliances, insurance, health care, for example.

PPI feeds into the Fed’s preferred measure of inflation: the personal consumption expenditures price index, said Paul Ashworth, chief North America economist at Capital Economics. 

“Yesterday we learned that CPI was pretty weak. Today we learned that PPI was pretty weak too. Put those together, and it suggests the PCE measure is also pretty weak,” he said.

Still, the Fed’s stance on inflation and interest rate cuts just got more hawkish, said Scott Wren, senior global marketing strategist at the Wells Fargo Investment Institute.

“Inflation is slowly moving lower. It’s still far too high for the Fed. They need more convincing,” he said.

More convincing that inflation really, truly is heading toward the Fed’s long-term target of 2%.

Meanwhile, there’s still a lot of inflation pain in the economy.

“Definitely, our clients are seeing a very strong effect from inflation, a marked increase in claims,” said Dan North. He’s a senior economist at credit insurer Allianz Trade, which pays out to suppliers when their customers pay late or don’t pay a bill, say, for merchandise shipped to a store that the store can’t sell. 

“You know, consumers change their buying habits, they move from steak to chicken, from the upper shelf down to the lower shelf,” he said.

And those consumers are seriously bummed out. 

Wren at Wells Fargo pointed out prices have outpaced wages over the past four years. And even though inflation is coming down, prices are still going up.

“They’re just going up at a slower pace. But what consumers — I mean, they want deflation. They want to see prices where they were in 2019,” he said.

And he said that is just not going to happen.