US August CPI to Show Slowing Inflation?

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It’s no surprise that politics has an impact on inflation expectations. But the political wrangling in Washington right now might have almost direct consequences in consumer prices.

The economic debate raging now is if, and how much, inflation there will be in the coming months. Government expenditures play a key role. Right now, Democrats and Republicans are at loggerheads on a new massive stimulus bill. Depending on how that works out, it could influence inflation expectations.

The latest jobs numbers added a wrinkle to the discussion. The Trump administration broadly interpreted it to be positive.

Increasingly more Republicans are feeling comfortable with the idea that a second stimulus bill isn’t necessary as job numbers improve. Many argue that as time goes on, the usefulness of government spending diminishes, as the economy recovers.

The Two Big Inflationary Aspects

Meanwhile, Democrats are adamant in their demands. They state that some degree of monetary support should be provided to states and municipalities which are experiencing cash flow problems due to lower tax revenues following the lockdowns.

Of the different types of government spending, municipal is the most likely to lead to increases in the cost of living. Republicans refuse to bail out states they say have mismanaged their finances prior to the pandemic and therefore were unable to handle it.

In the disagreement, Republican Senate Majority Leader McConnell yesterday announced that he will introduce to a vote his party’s version of a relief bill. One side calls the much smaller stimulus “skinny”. The other side rejected it as “emaciated”.

But, even if the bill passes the Senate, it’s unlikely to be discussed in the House. The risk is no bill could pass. This is the scenario most likely to keep inflation expectations on hold. Counterintuitively that would likely weaken the dollar. Traders may expect the Fed’s easing cycle to be even more protracted than last time.

What We Are Looking For

For the data release, we want to pay close attention to the CPI ex Food and Energy number (often called the “core”). This is because the Fed tracks this for policy decisions. Compared with the 0.6% prior, analysts project monthly core inflation to slow down to 0.2%. Annualized, it comes out to 1.6%. This is unchanged from 1.6% in the prior month.

Including more volatile elements (that is, the inflation number reported by the press), monthly inflation is projected to come in at 0.3%. This is compared to 0.6% in July. Annualized, it would be just 1.2% compared to 1.0% prior. This reflects the deflationary impact of lower crude prices.

Inflation Outlook

Since the beginning of the coronavirus, the Fed has led an unprecedented increase in the monetary base, expanding M2 supply by almost $3T (or about 20%). But, since mid-July, the amount has largely stabilized. The Fed appears to be attempting to maintain the monetary base stable.

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