RBC Capital Market's Francis Donald Talks June CPI

**SPEAKER_1** (0:02)
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**SPEAKER_2** (0:07)
We continue on the state of the American economy. Frances Donald joins as chief economist, RBC Capital Markets. You've had all of eight minutes, Frances, to digest the CPI report. Is it a one-off disinflationary tendency, or do you detect a trend?

**Frances Donald** (0:27)
Well, facetiously, when I saw the core CPI come in flat, I thought, oh, Kevin Warsh was the most successful Fed chair ever. He's done it in a matter of weeks. He's solved for the inflation challenge in play. Except that, to your point, what we're seeing this month is entirely the energy drag, explaining the headline decline. And there's enough going on in core CPI to tell us that these are probably some volatile components, like motor vehicle insurance and wireless telephones, though it has have dragged on core CPI. Underneath the surface, I am still concerned. And firstly, I don't know that we should be saying inflation is totally solved when core inflation in America is still at 2.6%.
We are over five years of inflation above target, and we still have some pretty serious issues in the areas that matter most to consumers, like food, which is up 3% and still likely to accelerate ahead. And an extremely tight labor market that reminds me of the good old-fashioned demand-led inflation, which is still in the system as well. So I think two things can be true. We can celebrate that we've had some reprieve here this month in many areas of the report. This is good news for Chair Warsh as he heads into testimony, but it is too early to take our eye off the ball.

**SPEAKER_4** (1:44)
Francis, would I get thrown out of the Federal Reserve if I walked in and said, you know what, in today's world order, 2.5% core CPI, that's fine. I mean, in a world where globalization is going by the highway here and it's all, you know, every man for himself, costs are going to be higher. That's just the way it is. What happens then?

**Frances Donald** (2:05)
Would you get thrown out? No, but you'd probably be relegated to the basement with a few other colleagues who share the view and you'd have to be really quiet about it.
I suspect that the way we have to think about inflation now really comes down to this idea of what is supply-led inflation and what is demand-led inflation. The San Francisco Fed actually breaks this out and what they find right now is that it's about half supply given and that's everything from AI to tariffs, to the Strait of Hormuz coming through and created blockages, but half of it is demand-led. This is the area that the Federal Reserve can control and should control. While we continue to focus on these big structural trends that are meaningful to price levels and price growth, I think this Federal Reserve is really going to struggle more with the old-fashioned types of inflation and that's because, Tom, if you've highlighted many times this morning, nominal growth is very strong in America. The labor market is extraordinarily tight. There is a massive infrastructure build coming out. It is the Gilded Age 2 and you have an exceptionally wealthy top 1 percent consumer. Those are the types of things that drive demand-led inflation. So the Fed can be excused and all central banks globally can be excused for wanting to look through supply-led inflation that may be big as above 2 percent, but they have to stay focused on demand side. And that's where my concern in the second half of the year is, much more so than are we seeing energy coming up or down in a month to month.

**SPEAKER_4** (3:38)
So I'm looking at the work function here, still looking for almost two rate hikes this year. Does that seem reasonable to you?

**Frances Donald** (3:47)
We have the Fed on hold and of course, it's natural to say, okay, well, what does this number mean for the Fed? But I look at this number now from a different lens, which is what does this inflation mean for the consumer and tell us about the consumer? Because at the end of the day, what will matter for most businesses, for anyone picking stocks, for those who are trying to serve, is what is this telling us about the consumer? It's telling us that the consumer is not struggling under the same gasoline prices that they were last month. It's telling us there are certain items that they'll get some reprieve on, but it's still telling us that prices are too high for most consumers. And when you combine the CPI number with the fact that we no longer have tax-free funds, that we have seen savings eroded, this is a consumer that may have had some reprieve now, but if we see another price shock in the second half of the year, whether energy prices rise again, whether food prices rise or reprieve, I don't believe this is a consumer that can withstand that, and you'll see pricing powers eroded.