Fed’s Tough Talk Could Be Transitory


“Whip Employment Now” would be a bad slogan but, in its efforts to bring inflation down, it is a message that the Federal Reserve is at risk of sending.

When he spoke at the Kansas City Fed’s annual economic symposium in August 2021, Fed Chairman

Jerome Powell

detailed why the run up in inflation would likely be transitory. Needless to say, his message on Friday at this year’s symposium was different.

Fed policy makers’ “overarching focus right now is to bring inflation back down to our 2% goal,” Mr. Powell said. Doing so will require further rate increases, he continued, and slower growth and a softer labor market that “will also bring some pain to households and businesses.”

The immediate message for investors is that at their meeting next month policy makers might well raise their target range on overnight rates by 0.75 percentage point again—and if next Friday’s August jobs report is strong, that will seem all but certain. Moreover, though it seems likely that in later meetings the Fed will raise rates by smaller increments, tightening will continue until the central bank believes inflation will be contained.

Or at least that is the plan. What could complicate matters for the Fed is that inflation is now dropping fast—perhaps only temporarily, and largely (though not only) because gasoline prices are falling, but dropping nonetheless.

On Friday the Commerce Department reported that its measure of consumer prices, which is the Fed’s preferred inflation gauge, fell 0.1% in July from June. That put it 6.3% above its year-earlier level, which is high, but not as high as the 6.8% hit in June. Core prices, which exclude food and energy items in an effort to better track inflation’s trend, rose by 0.1% from a month earlier, marking their smallest monthly gain since November 2020, and were up 4.6% from a year earlier, which was the lowest on-the-year gain since October 2021.

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Coming inflation reports will likely show more relief. The drop in the average price of gasoline this month has been even more pronounced than in July, and futures prices suggest it will continue to fall. Many retailers are employing discounts in an effort to reduce unwanted inventory. Used-car prices, which have been an important source of inflation, are dropping. Sharp declines in container shipping rates are a reflection of easing supply-chain woes.

None of which is to say that inflation has been beat. Rents, which both the Commerce Department and Labor Department use to measure overall shelter costs, will likely be putting upward pressure on inflation readings for months to come. A tight labor market has given rise to wage gains that the Fed worries will feed through into higher prices.

But consider the optics. It is one thing to raise rates when gasoline—for many Americans the most salient measure of inflation—fetches $5 a gallon. It is another when it has slipped to $3.87 and is falling every day. It is one thing to raise rates when overall inflation readings are heating up, and another when they are cooling. The Fed’s efforts to slow down the job market might suddenly be less appreciated.

The best thing for the Fed would be for signs to emerge that inflationary pressures are unambiguously easing. Otherwise, it could have a fight on its hands.

Write to Justin Lahart at Justin.Lahart@wsj.com

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