Skip to main content

Q3 2023 Market Commentary

October 30, 2023

The Inflation Fight Continues

“Anything worth doing is worth overdoing.” – Mick Jagger (Rolling Stones)

The Federal Reserve continues its fight to bring inflation down to its two percent target on the Consumer Price Index (CPI). Recently, Jerome Powell and his flock of Fed governors have turned to using words to influence markets. Sayings like “higher for longer” are back in vogue. This three-word mantra is meant to express that the Fed may not, in fact, raise interest rates any further; however, the enthusiasm around possible rate cuts on the horizon should be curbed. As the below chart from JP Morgan Asset Management illustrates, the Fed is communicating that the policy rate it directly controls will be at 5.10% by year end 2024. Which is a mere stone’s throw from the current level of 5.25%.

How the Fed Looks at Inflation

As with many economic measures, there are different ways to look at the same indicator and inflation is no exception. As an institution, the Fed has preferred ways at looking at data. With respect to inflation since the Greenspan era, circa 2000, the Fed’s favored way of looking at inflation is the Personal Consumption Expenditure, or PCE. Without going into an absurdly long diatribe about the differences in the calculation of CPI and PCE, the main reason the Fed watches PCE a bit more closely is that the weighting of the various categories of consumer spending change more frequently, which may mimic consumer substitution tendencies more closely than the CPI. That said, we have been interested in understanding whether what the Fed has done with interest rates in the last 18 months has, indeed, impacted PCE. By virtue of inflation falling, are rate increases doing the trick? Enter cyclical versus acyclical inflation. The chart below, from Alpine Macro via the San Francisco Fed, shows a divergence between the two types of inflation that make up the PCE metric. Cyclical inflation includes categories that are determined more by overall economic activity – i.e., aggregate demand – while acyclical inflation includes categories that are more impacted by industry specific factors, such as productivity.

If we take the case that interest rate increases are meant to slow aggregate demand or cyclical inflation, it appears that this chart is telling us that the Fed has had little impact on inflation emanating from overall demand. After lifting rates at the fastest pace in 40 years, we could find ourselves in a situation where demand-driven inflation may fall fast, and monetary policy has been tightened too much. Stay tuned.


As we have written in these pages in the past, the Fed will likely err on the side of being overly aggressive in tackling inflation. This view comes from the fact that the Fed kept monetary policy too easy coming out of the pandemic and caused the bout of inflation they are fighting today – they can’t afford to be wrong about inflation twice. Therefore, the risk might be that the Fed overdoes it on this tightening campaign in the face of demand that could soften very quickly. This may present a challenge to risk assets as we head into year end.