After several 75 basis point rate hikes last year, the Fed appears to be easing up on its tightening cycle. While the central bank still has its work cut out, recent data reveals we’re in a much better place now than we were this time last year. 

Consumer price inflation (CPI) fell to 6.4% on an annual basis in January. That is down from 6.5% in December and 9.1% at its peak in June 2022. Consumers had seen overall deflation in December largely due to falling gas prices from November to December. But CPI jumped by 0.5% in January in response to higher energy prices. Despite that monthly gain, Core PCE, which sources data from businesses, is showing encouraging progress on inflation. 

The Fed’s favored PCE inflation measure for December fell to 4.4% year over year from 4.7% in the prior month and its peak rate of 5.4% last February. The three-month annual rate of change was also impressive at 2.9%, with average month-over-month gains of 0.24%. Economists have recently been highlighting CPI reports with two-digit precision since monthly changes of approximately 0.2% may or may not signal an acceptable glide path to the Fed’s 2% target.  

The ISM Services Prices Paid Index is also showing further progress on inflation. The index, which is a part of the ISM United States Manufacturing Purchasing Managers Index, reflects a change in prices paid by industry representatives for the products or services they receive. The index fell from a peak of 84.5 in December 2021 to 68.1 in December 2022, marking the third consecutive month that the index had declined.    

With the exception of October, the index has declined every month since March 2022. Since it tends to lead Core PCE by two months, this points to Core PCE inflation falling below 4% on a year-on-year basis in the current quarter. That could mean more positive inflation news in the pipeline, despite the Fed’s concerns over the tight labor market and sticky services inflation.  

While the historical correlation between money growth and inflation has often been very loose, the fact that the U.S. money supply is collapsing after an incredible surge is a positive sign. The U.S. M2 Money Supply is the Fed’s estimate of the total money supply including all the cash people have on hand, plus all the money deposited in checking and savings accounts, and other short-term savings vehicles such as CDs.  

One of the ways the Fed balances its dual mandate of unemployment and inflation is to manipulate the M2 money supply. When the money supply increases by a large margin, it can lead to high inflation, which we have been seeing. The Fed can constrict the money supply to help tame that inflation. After posting peak year-over-year growth of 27% in February 2021, U.S. money growth turned negative in December with a -1.3% year-over year-decline, which is fueling optimism that inflation will also collapse. 

The Core PCE, the Fed’s favored inflation measure, fell year-over-year, while the Services PMI Prices index also fell for the third consecutive month. Since the PMI Prices index tends to lead Core PCE by two months, Core PCE inflation could fall even more during this quarter. In addition, U.S. money growth turned negative in December, which is also fueling inflation optimism. While it could be a while before we see substantially lower prices at the supermarket and the gas tank, it appears the Fed has inflation headed in the right direction.