US core inflation has peaked

 The core CPI/inflation rate excludes energy and food prices, but of course, both these sectors indirectly contribute to rising prices in the rest of the economy.  It is one of the measures the Fed watches closely to determine monetary policy.  (But it also looks at wage inflation and the strength of the overall economy).  

One of the fears it has is that cost-push inflation (oil prices, global supply chain difficulties, the Russian war on Ukraine, labour supply declines due to long covid, food price increases because of global warming) will feed into broader inflation.  So before it stops raising the Fed Funds (discount) rate, it will need to see not just core inflation, but also wage inflation, slow.  As the second of the charts below shows, the latter isn't really happening yet.

Note how wages spiked during the Covid Crash, then, because of the year-on-year calculation effect, appeared to slow in 2021.  Year-on-year wage inflation is still running at 6%.   That wouldn't be a problem if productivity growth was also running at 6%.  And it was, during the crash.  But recently, it's been negative.  In addition, payroll growth is still above 200K per month.  The Fed tends to raise rates when payroll growth is above that level, and cut them when payroll growth is negative.  This is not because it's hostile to employment growth, but because payroll growth is a very good proxy for overall GDP growth.

And so the Fed is likely to go on raising rates for the next few months as it waits for three things:

1. A sustained low level of core inflation, or at least a sustained downward trend.  A couple of months' data are not enough to confirm a trend
2. Slowing wage inflation (less important than core inflation to the Fed, I suspect, because it understands that in current market conditions, wage growth is a lagging indicator.)
3. Payroll growth dipping materially below 200K per month.

In my judgement, further rate rises would be a mistake.  Cost-push inflation is very hard to fight unless you push the economy into deep recession.  My leading indicators already confirm the probability of a recession in 2022, perhaps even a deep recession.  Some of the cost-push indicators are improving (the oil price is falling; supply chain difficulties, though still present, are improving), so caution is advisable.  A pause in rate rises makes sense.

The people I've met at the Fed (though that was two decades ago!) have been formidably intelligent and well-educated, and they must surely be doing the same calculus I am. So it will be interesting to see which way the Open Market committee jumps at the next meetings in January and March.  

Also beware: just because the Fed has stopped raising rates doesn't mean it's started cutting them.  And I suspect cuts in the Fed Funds rate are what will be needed to turn the share market, if there is indeed a recession.