Is the Fed Getting It Right?

William Sterling, Ph.D.


While it could be a while before we see substantially lower prices at the supermarket and the gas tank, it appears the Federal Reserve (the Fed) has inflation headed in the right direction.  


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. 

Core Personal Consumption Expenditures (PCE) Shows Progress on Inflation

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.  

U.S. Core PCE Inflation: 1-, 3-, and 12-Month Annualized Change

Source: GW&K Investment Management, BEA, and Macrobond.

Services PMI Points to Progress on Inflation

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.  

Reason for Optimism on Core PCE Inflation: ISM Services Price Leads Core Inflation by Two Months

Source:  GW&K Investment Management and Macrobond.

Collapsing Money Growth Fueling Inflation Optimism 

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. 

Money Growth Is Collapsing After an Incredible Surge: U.S. M2 Money Supply

Source: GW&K Investment Management, Federal Reserve, and Macrobond

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. 

Past performance is not a guarantee of future results.


Basis point is equal to 0.1%.


Investing involves risk, including possible loss of principal. There is no guarantee that these investment strategies will work under all market conditions, and each investor should evaluate their ability to invest for a long term, especially during periods of downturns in the market.


This does not constitute investment advice or an investment recommendation.


This represents the views and opinions of GW&K Investment Management. It does not constitute investment advice or an offer or solicitation to purchase or sell any security and is subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes.


Data is from what we believe to be reliable sources, but it cannot be guaranteed. GW&K assumes no responsibility for the accuracy of the data provided by outside sources.


© Copyright 2023 AMG Funds LLC. All rights reserved.



William Sterling, Ph.D.


PUBLISHED: March 14th, 2023
4 Min Read

Get Our Latest Posts Delivered Right To Your Inbox.

More Like This

The Looming End of an Era

October 14th, 2022 | by William Sterling, Ph.D.

Central banks around the world, including the Federal Reserve, are taking aggressive action to combat inflation in 2022. GW&K’s William Sterling, Ph.D., writes about how some are raising the alarm as recession fears deepen.

Read Blog

The Fed’s Search for Balance

April 28th, 2022 | by William Sterling, Ph.D.

The Federal Reserve raised its benchmark federal funds rate for the first time since 2018. The highly anticipated move is now driving a wider conversation on how high interest rates can go from here and, by extension, if the U.S. economy is inching closer to a recessionary period.

Read Blog
ESG Blog images

The Russia Shock and its Potential Effect on Fed Policy

March 22nd, 2022 | by William Sterling, Ph.D.

As the tragic human consequences of Russia’s aggressive invasion of Ukraine unfold, we can only guess at the intermediate longer-term economic and financial market implications.

Read Blog