Fed Whisperer: Rising MCT Inflation Undermines Calls for 50bps September Fed Cut

The conversation around potential Federal Reserve rate cuts in September has been intense, with opinions swinging between a moderate 25 basis points (bp) cut and a more aggressive 50 bp cut. However, the latest data on the Multivariate Core Trend (MCT) inflation, which showed a notable rise in July, is causing a recalibration of expectations.

Nick Timiraos, a prominent journalist covering the Federal Reserve for the Wall Street Journal, recently pointed out that the rise in "persistent" inflation metrics argues against a 50 bp cut, favoring a smaller reduction instead.

The Multivariate Core Trend (MCT) inflation measure increased to 2.5% in July from 2.2% in June (which was revised up from 2.1%), signaling that inflation pressures remain more entrenched than many had hoped.

This reading, published by the New York Federal Reserve, challenges the assumption that inflation is on a clear downward path, as suggested by other indicators.

With this context in mind, it is worth exploring what the MCT inflation measure is and why it holds significance for Federal Reserve policy decisions.

Understanding the Multivariate Core Trend (MCT) Inflation Measure

The MCT inflation measure was developed by the New York Federal Reserve to provide a more accurate and reliable gauge of the underlying inflation trend in the US economy.

Traditional measures, such as the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) index, often capture short-term fluctuations driven by volatile components like energy and food prices. These temporary price changes can obscure the true, underlying trend that is crucial for long-term economic planning and policy formulation.

The MCT, on the other hand, aims to filter out this noise by focusing on persistent inflation components.

The MCT uses a multivariate statistical model that integrates a wide range of economic variables, including core prices that exclude food and energy, as well as economic activity and financial conditions. This approach enables the MCT to separate short-term volatility from longer-term inflationary pressures, providing a more stable reading of inflation trends.

For policymakers, investors, and economists, this stability is valuable because it offers a clearer signal of where inflation may be headed, free from the distortions of temporary price spikes or dips.

Why the MCT Inflation Measure Matters Now

The MCT is particularly useful for the Federal Reserve in gauging inflation pressures that could influence monetary policy decisions, such as interest rate adjustments. With the latest MCT reading rising to 2.5% in July, it underscores that inflation pressures are not abating as quickly as some may have anticipated.

This puts into question the likelihood of a more aggressive 50 bp rate cut at the upcoming September Federal Open Market Committee (FOMC) meeting. Instead, the data supports a more cautious approach, with a 25 bp cut appearing more aligned with the current economic realities.

Several factors contribute to this outlook:

1. Comparison with Other Inflation Measures: Unlike the CPI or PCE, which can swing significantly due to food and energy prices, the MCT focuses on the underlying trend. Core CPI and Core PCE do exclude food and energy but may still be influenced by short-term price changes in other areas. The MCT's multivariate approach offers a more comprehensive picture, focusing on persistent inflation trends rather than temporary disturbances.

2. Implications for Monetary Policy: Given the MCT's focus on long-term inflationary pressures, its recent rise suggests that inflation is becoming more entrenched. This directly impacts the Fed's policy considerations. An aggressive rate cut could be perceived as premature or even risky if underlying inflationary pressures remain strong. A smaller, more measured cut would provide the Fed with the flexibility to respond to evolving economic data without overcommitting to a dovish stance.

3. Market Reaction and Expectations: Market participants have already been adjusting their expectations in light of the MCT data. While the probability of a 50 bp cut in September was higher earlier, it has since moderated as the persistence of inflation becomes clearer. This adjustment in expectations also reflects broader market sentiment that inflation may not be easing as quickly as hoped.

Challenges and Limitations of the MCT Approach

While the MCT provides valuable insights, it is not without its limitations. As with any model-based measure, its accuracy depends on the assumptions and variables included. Predicting future inflation trends is inherently uncertain, and the MCT is no exception.

Nonetheless, by taking a multivariate approach, the MCT attempts to offer a more holistic view of inflation dynamics than traditional single-measure indices like the CPI or PCE.

In conclusion, the rise in the MCT inflation measure in July adds weight to the argument against a more aggressive 50 bp rate cut in September. As the Federal Reserve continues to navigate the complexities of post-pandemic economic recovery, the emphasis will likely remain on cautious and data-dependent decision-making.

Investors, policymakers, and market watchers should keep a close eye on future MCT readings and other inflation indicators as they provide essential clues about the trajectory of US monetary policy.