A family shops for Halloween candy at a Walmart Supercenter on October 16, 2024 in Austin, Texas.
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Just because the Fed is close to its inflation target does not mean the problem has been solved, as rising prices for goods and services across the US economy continue to be a burden on individuals, businesses and policymakers.
Recent price reports for goods and services, although slightly stronger than expected, suggest that the inflation rate over the past year is close to the central bank's target of 2%.
In fact, Goldman Sachs recently estimated that when the Bureau of Economic Analysis later this month publishes its numbers on the Fed's preferred measure of prices, the inflation rate could be close enough to bring it closer to the 2% level.
But inflation is a mosaic. It cannot be fully measured by any single metric, and by many measures it is still well above the level at which most Americans, and even some Fed officials, feel comfortable.
Like many of her colleagues, San Francisco Fed President Mary Daly on Tuesday touted easing inflation pressures, but 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,” she told a group gathered at New York University's Stern School of Business.
Inflation is not dead
Daly began her talk with an anecdote about a recent encounter she had while walking near her home. A young man pushing a stroller and walking a dog shouted: “President Dali, are you declaring victory?” She assured him that she was not waving any signs when it came to inflation.
But the conversation summed up a dilemma for the Fed: If inflation is rising, why are interest rates still so high? Conversely, if inflation has not yet been cut – those of you in the 1970s may remember the “Hit Inflation Now” buttons – why would the Fed cut interest rates at all?
In Daly's view, the Fed's half-percentage-point cut in September was an attempt at “right sizing” policy, to bring the current interest rate climate in line with inflation that is well below its mid-2022 peak at the same time as inflation. Low. Signs of a declining labor market.
As is clear from the young man's question, convincing people that inflation is abating is a difficult matter.
When it comes to inflation, there are two things to remember: the inflation rate, which is the 12-month view that grabs the headlines, and the cumulative effects that more than three years have had on the economy.
Looking at the 12-month average provides only limited insight.
The annual rate of CPI inflation was 2.4% in September, a significant improvement from the high of 9.1% in June 2022. The CPI measure attracts the bulk of public focus but is secondary to the Federal Reserve, which favors the PCE price index from Consumer price index. Department of Commerce. Taking the inputs from the CPI that feed into the personal consumption expenditures measure led Goldman to conclude that the latter measure represents only a few hundredths of a percentage point from 2%.
Inflation first exceeded the Fed's 2% target in March 2021, and for months was dismissed by Fed officials as a “temporary” product of pandemic-specific factors that would soon subside. In his annual policy speech at the Jackson Hole, Wyoming, summit last August, Federal Reserve Chairman Jerome Powell joked about the “good ship that is passing” and all the passengers on board in the early days of rising inflation.
Clearly, the inflation was not temporary, and the CPI reading for all items has risen 18.8% since then. The food price inflation rate rose to 22%. The price of eggs rose 87%, car insurance rose 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 jumped 16% since the first quarter of 2021, and 30% since the start of the pandemic-fueled buying frenzy.
Finally, while some broad measures of inflation such as the CPI and personal consumption expenditures are declining, other measures are showing stubbornness.
For example, the Atlanta Fed's measure of “fixed price” inflation — such as rent, insurance and Medicare — was still running at 4% in September even as the “elastic CPI,” which includes food, energy and vehicle costs, fell. Outright contraction at -2.1%. This means that prices that don't change much are still high, while prices that do change, in this particular case gasoline, are falling but may shift in the other direction.
The constant price measure also raises another important point: “core” inflation, which excludes food and energy prices, which fluctuate more than other items, remained at 3.3% in September as measured by the CPI and 2.7% in August as measured by the CPI. Personal consumption expenditures index.
While Fed officials have recently been talking more about headline numbers, they have historically viewed the headline number as a better measure of longer-term trends. This makes inflation data even more disturbing.
Borrow to pay higher rates
Before the 2021 spike, American consumers were accustomed to negligible inflation. However, during the current period, they continue to spend, spend, and spend some more despite all the grumbling about the rising cost of living.
In the second quarter, consumer spending reached nearly $20 trillion at an annual pace, according to the Bureau of Economic Analysis. In September, retail sales increased by a larger-than-expected 0.4%, with the group that feeds directly into GDP calculations up 0.7%. However, year-over-year spending rose only 1.7%, below the CPI inflation rate of 2.4%.
An increasing portion of spending has come through debt securities in various forms.
Total household debt reached $20.2 trillion during the second quarter of this year, an increase of $3.25 trillion, or 19%, since inflation began rising in the first quarter of 2021, according to Federal Reserve data. In the second quarter of this year, household debt rose by 3.2%, the largest increase since the third quarter of 2022.
So far, high debt hasn't proven to be a big problem, but it's starting to get there.
The current delinquency rate is 2.74%, the highest in nearly 12 years, though still slightly below the long-term average of about 3% in Fed data dating back to 1987. However, a poll showed A recent New York Federal Reserve Bank survey found that the perceived likelihood of missing a minimum debt payment within the next three months jumped to 14.2% of respondents, the highest level since April 2020.
And it's not just consumers who get credit.
Small business credit card use has continued to rise, rising more than 20% compared to pre-pandemic levels and nearing its highest levels in a decade, according to Bank of America. Economists at the bank expect that pressure may ease as the Fed cuts interest rates, although the size of the cuts may come into question if inflation proves flat.
In fact, the only bright spot in the small business story when it comes to credit balances is that they haven't actually kept up with the 23% increase in inflation since 2019, according to Bank of America.
However, overall, sentiment is pessimistic in small caps. The September poll by the National Federation of Independent Business showed that 23% of respondents still see inflation as their main issue, and again the most important issue for members.
Choose the Federal Reserve Bank
Amid the swirling currents of the good news/bad news inflation picture, the Fed has an important decision to make at its policy meeting scheduled for November 6-7.
Since policymakers voted in September to cut key interest rates by half a percentage point, or 50 basis points, markets have behaved strangely. Instead of pricing at lower rates in the future, they are starting to indicate a higher trajectory.
For example, the interest rate on a 30-year fixed mortgage has risen about 40 basis points since the cut, according to Freddie Mac. the 10-year Treasury bond yield rose by a similar amount, and the five-year break-even rate, a gauge of bond market inflation that measures five-year government securities against inflation-protected Treasury securities of the same duration, rose by about a quarter point and was recently at its highest levels since early July.
SMBC Nikko Securities was the lone Wall Street voice encouraging the Fed to take a break from cuts so it can get greater clarity on the current situation. The company's position was that with stock market prices surpassing new records and the Fed shifting into easy-money mode, an easing of financial conditions threatens to push inflation higher again. (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 ease financial conditions, thereby enhancing the wealth effect through higher stock prices. At the same time, the charged inflationary backdrop should persist,” said Joseph LaVorgna, chief economist. At SMBC, who was Donald Trump's top economist. The Trump White House wrote in a memo on Friday.
This makes people like the young man Daly encountered, the head of the Federal Reserve Bank of San Francisco, feel uneasy about the future and hint at whether the Fed is making a policy mistake.
“I think we can move toward (a world) where people have time to catch up and then move forward,” Daly said during her speech in New York. “That is, I told the young father on the sidewalk my version of victory, and then I would consider the mission accomplished.”