Inflation is slowing but the Fed’s next move is still up in the air

Federal Reserve officials head into their policy meeting Tuesday closer to their goal of low inflation, but how much they will ease back on interest rates remains an open question.

A week’s worth of inflation data showed that price pressures have eased substantially since their meteoric rise in 2021-22. One gauge of consumer prices showed 12-month inflation at its lowest since February 2021, while wholesale price measures indicated pipeline price increases are mostly under control.

Both readings were certainly enough to clear the way for an interest rate cut at the Federal Open Market Committee meeting, which concludes Wednesday with a rate decision and an updated forecast on where central bankers see things heading in the future.

“We got two more months of good inflation data” since the last Fed meeting, Claudia Sahm, chief economist for New Century Advisors, said in a CNBC interview Friday. “That’s what the Fed asked for.”

The question, though, turns now to how aggressively the Fed should act. Financial markets, which provide a guidepost on where the central bank is heading, were no help.

Futures markets for most of the past week had lasered in on a quarter percentage point, or 25 basis point, rate cut. However, that turned on Friday, with traders switching to an almost even chance of a either a 25- or a half point, or 50-basis point-reduction, according to the CME Group’s FedWatch tool.

Sahm is among those who think the Fed should go bigger.

The inflation data “on its own would have gotten us 25 next week, as it should, and will get us a whole string of cuts after that,” she said. “The federal funds rate has been over 5%, has been there for over a year to fight inflation. That fight is won. They need to start getting out of the way.”

That means, Sahm said, starting off with a 50 basis-point reduction as a way to put a floor under potential labor market decay.

“The labor market [since] last July has gotten weaker,” she said. “So there’s an aspect of just recalibrating. We got some more information. [Fed officials] need to kind of clean it up, do a 50 basis point cut and then be ready to do more.”

The inflation reports indicate that the battle to bring inflation back down to 2% isn’t exactly over, but things are at least moving in the right direction.

The all-items consumer price index nudged up just 0.2% in August, putting the full-year inflation rate at 2.5%. Excluding food and energy, core inflation stood at 3.2%, a good deal farther away from the Fed’s target.

However, most of the core strength has come from stubbornly high shelter costs, boosted by the Bureau of Labor Statistics’ byzantine “owners equivalent rent” measure that asks homeowners what they could…