Why Inflation May Look Like It’s Going Down But It’s Still a Big Problem

Just because the Federal Reserve is getting closer to its inflation target does not mean the problem is solved, as the high price of goods and services throughout the U.S. economy continues to burden individuals, businesses and organizations. authorities.

Recent reports of prices for goods and services, despite being a little stronger than expected, indicate that the inflation rate over the past year is approaching the central bank’s 2% target.

In fact, Goldman Sachs recently estimated that when the Bureau of Economic Analysis releases its numbers on the Fed’s favorite price measure later this month, the inflation rate could be close enough to round down to that 2% level.

But inflation is a mosaic. It cannot be fully captured by any individual criteria, and by many metrics it is still well above where most Americans, and indeed some Federal Reserve officials, are comfortable.

Like many of her colleagues, San Francisco Fed President Mary Daly last Tuesday touted easing inflationary pressures, but she noted that the Fed is neither declaring victory nor eager to rest on its laurels. .

“Continued progress toward our goals is not guaranteed, so we must remain vigilant and intentional,” he told a group gathered at New York University’s Stern School of Business.

Daly began his talk with an anecdote from a recent encounter he had while walking near his house. A young man pushing a stroller and walking a dog shouted, “President Daly, are you declaring victory?” She assured him that she was not waving any banners when it came to inflation.

But the conversation summed up a dilemma for the Federal Reserve: If inflation is rising, why are interest rates still so high? On the other hand, if inflation hasn’t been whipped yet (those who were around in the 1970s may remember the “Smite Inflation Now” buttons), why is the Fed cutting?

In Daly’s eyes, the Fed’s half-percentage-point cut in September was an attempt to “right-size” policy, to align the current rate climate with inflation that is a long way from its mid-peak peak. 2022, at the same time that there are signs that the labor market is weakening.

As the young man’s question demonstrates, convincing people that inflation is declining is a difficult task.

When it comes to inflation, there are two things to remember: the inflation rate, which is the headline-grabbing 12-month view, and the cumulative effects that a streak of more than three years has had on the economy.

Looking at the 12-month rate provides only a limited view.

The annual CPI inflation rate was 2.4% in September, a big improvement from the peak of 9.1% recorded in June 2022. The CPI measure attracts the most public attention, but is secondary versus the Federal Reserve, which prefers the Commerce Department’s personal consumption expenditures price index. Taking the CPI data that feeds the PCE measure, Goldman concluded that the latter measure is just a few hundredths of a percentage point away from 2%.

Inflation first surpassed the Fed’s 2% target in March 2021 and for months was dismissed by Fed officials as the “transitory” product of pandemic-specific factors that would soon recede. Federal Reserve Chairman Jerome Powell, in his annual policy speech at the Jackson Hole, Wyoming, summit last August, joked about “the good ship Transition” and all the passengers it had in the early days of the surge. inflation.

Obviously, inflation was not temporary and the CPI reading for all items has increased by 18.8% since then. Food inflation has increased by 22%. Eggs are up 87%, auto insurance is up almost 47%, and gasoline, although on a downward trajectory these days, is still up 16% since then. And, of course, there’s housing: The median home price has risen 16% since the first quarter of 2021 and 30% since the start of the pandemic-fueled buying frenzy.

Finally, while some broad inflation measures, such as the CPI and PCE, are receding, others are showing stubbornness.

For example, the Atlanta Fed’s “sticky price” inflation measure (think rent, insurance and health care) was still running at a 4% rate in September, even as the “flexible CPI,” which includes Food, energy and vehicle costs were on the rise. an absolute deflation of -2.1%. That means that prices that don’t change much remain high, while those that do, in this particular case gasoline, are falling but could swing in the opposite direction.

The sticky price measure also raises another important point: “core” inflation, which excludes food and energy prices, which fluctuate more than other items, was still at 3.3% in September according to the CPI and at 2.7% in August according to the CPI. PCE index.

While Federal Reserve officials have been talking more about the headline numbers lately, they have historically considered the core to be a better measure of long-term trends. That makes the inflation data even more problematic.

Before the 2021 peak, American consumers had become accustomed to negligible inflation. Still, during the current streak, they have continued to spend, spend, and spend some more despite all the complaints about the rising cost of living.

In the second quarter, consumer spending amounted to nearly $20 trillion at an annualized pace, according to the Bureau of Economic Analysis. In September, retail sales rose a more than expected 0.4%, and the group that directly influences gross domestic product calculations rose 0.7%. However, year-over-year spending increased only 1.7%, below the CPI inflation rate of 2.4%.

An increasing portion of spending comes from IOUs of various forms.

Household debt rose to $20.2 trillion during the second quarter of this year, an increase of $3.25 trillion, or 19%, since inflation began to soar in the first quarter of 2021. according to data from the Federal Reserve. In the second quarter of this year, household debt increased by 3.2%, the largest increase since the third quarter of 2022.

So far, rising debt has not turned out to be a major problem, but it is becoming one.

The current debt default rate is 2.74%, the highest in nearly 12 years, although still slightly below the long-term average of about 3% according to Federal Reserve data dating back to 1987. However, a recent survey by the New York Federal Reserve showed that the perceived likelihood of missing a minimum debt payment over the next three months jumped to 14.2% of respondents, the highest level since April. 2020.

And it’s not just consumers who are stocking up on credit.

Small business credit card usage has continued to rise, up more than 20% compared to pre-pandemic levels and approaching the highest level in a decade, according to Bank of America. The bank’s economists hope the pressure could ease as the Federal Reserve cuts interest rates, although the magnitude of the cuts could be in doubt if inflation becomes persistent.

In fact, the only bright spot in the small business story regarding credit balances is that they haven’t really kept pace with the 23% inflation increase dating back to 2019, according to BofA.

However, overall, sentiment is pessimistic among small companies. The September survey by the National Federation of Independent Business showed that 23% of respondents still consider inflation as their main problem, again the main issue for members.

Amid the inflation outlook’s swirling currents of good news and bad news, the Federal Reserve has an important decision to make at its Nov. 6-7 monetary policy meeting.

Since the authorities voted in September to reduce their base interest rate by half a percentage point, or 50 basis points, markets have acted in curious ways. Instead of pricing in lower rates going forward, they have begun to signal a higher trajectory.

The rate on a 30-year fixed mortgage, for example, has risen about 40 basis points since the cut, according to Freddie Mac. 10-Year Treasury Yield has risen by a similar amount, and the 5-year breakeven rate, a gauge of bond market inflation that measures the 5-year government note against the Inflation Protected Treasury Security of the same duration, has risen by about of a quarter point and was recently at its highest level since early July.

SMBC Nikko Securities has been a lone voice on Wall Street encouraging the Federal Reserve to take a break from cuts until it can get more clarity on the current situation. The firm’s position has been that, with stock market prices eclipsing new records as the Federal Reserve has entered easing mode, weakening financial conditions threaten to push back inflation. (Atlanta Fed President Raphael Bostic recently indicated that a pause in November is a possibility he is considering.)

“For Fed policymakers, lower interest rates are likely to further ease financial conditions, thereby boosting the wealth effect through higher stock prices. In the meantime, a tense inflationary environment,” SMBC chief economist Joseph LaVorgna, who was a senior economist in Donald Trump’s White House administration, wrote in a note Friday.

That leaves people like the young man Daly, president of the San Francisco Federal Reserve, found himself uneasy about the future and hinting at whether the Fed may be making a policy mistake.

“I think we can move forward [a world] where people have time to catch up and then get ahead,” Daly said during his talk in New York. “I mean, I told the young father on the sidewalk my version of victory, and that’s when I’ll consider the job done . “