Why inflation appears to be easing, but remains a huge problem

Just because the Federal Reserve is close to his inflation This goal does not mean the problem is solved, as high prices for goods and services throughout the U.S. economy continue to be a burden on individuals, businesses, and policymakers.

Recent reports on prices of goods and services, although somewhat higher than expected, indicate that last year’s inflation rate is moving closer to the central bank’s 2% target.

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

But inflation is a mosaic. No individual standard can fully capture it, and by many indicators it is still well above what most Americans, and indeed some Fed officials, feel comfortable with.

Like many of her colleagues, San Francisco Fed President Mary Daly last Tuesday touted easing inflationary pressures, but noted that the Fed is not declaring victory and is not 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.

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

But the conversation summed up a dilemma for the Fed: If inflation is running high, why are interest rates still so high? Conversely, if inflation still hasn’t been brought under control – those who were around in the 1970s may remember the “whip inflation now” buttons – why is the Fed cutting rates?

In Daly’s eyes, the Fed’s half-percentage-point cut in September, it was an attempt to “right-size” policy, to align the current rate climate with inflation that is far from its peak in mid-2022, just as signs of slowing of the labor market appear.

As the young man’s question shows, it is difficult to convince people that inflation is slowing.

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

Looking at the 12-month rate provides only limited insight.

The annual rate of CPI inflation was 2.4% in Septembera marked improvement from the peak of 9.1% reached in June 2022. The CPI measure receives most of the public’s attention but is secondary to the Fed, which prefers the consumer price index. personal consumption expenditures from the Commerce Department. Taking into account the CPI data that powers the PCE measure, Goldman came to the conclusion that the latter measure represents only a few hundredths of a percentage point of 2%.

Inflation first exceeded the Fed’s 2% target in March 2021 and was dismissed for months by Fed officials as the “transitory” product of pandemic-specific factors that would soon recede . Chairman of the Fed Jerome Powellin his annual political speech to Jackson Hole Summit, Wyoming last August he joked about “the good ship Transitory” and all the passengers it carried when inflation began to rise.

Clearly, inflation has not been transitory and the All-items CPI has increased by 18.8% since then. Food inflation jumped 22%. Eggs are up 87%, car insurance has soared nearly 47% and gasoline, although on a downward trajectory these days, is still up 16% since then. And of course, there is accommodation: the median house price has jumped 16% since the first quarter of 2021 and 30% since the pandemic-fueled buying frenzy began.

Finally, while some broad measures of inflation, like the CPI and PCE, are declining, others are showing stubbornness.

For example, the Atlanta Fed’s measure “sticky price” inflation – think rent, insurance and medical care – was still at a rate of 4% in September, even though the “flexible CPI”, which includes the costs of food, energy and vehicles, was in pure and simple deflation at -2.1%. This means that prices that don’t change much remain high, while those that do change, in this particular case of gasoline, fall but could go the other way.

Measuring sticky prices 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 by the CPI measure and 2.7% in August by the CPI estimate. PCE index.

Although Fed officials have recently talked more about headline numbers, they have always viewed fundamental numbers as a better measure of long-term trends. This makes the inflation data even more problematic.

Before the 2021 peak, U.S. consumers had become accustomed to negligible inflation. Still, during the current period, they have continued to spend, spend, and spend some more, despite all the grumbling over the soaring cost of living.

In the second trimester, consumer spending is nearly $20 trillion at an annualized rate, according to the Bureau of Economic Analysis. In September, retail sales rose 0.4% more than expectedthe group which enters directly into the calculations of gross domestic product up 0.7%. However, year-over-year spending increased by only 1.7%, below the CPI inflation rate of 2.4%.

A growing share of expenses comes from IOUs in various forms.

Household debt totaled $20.2 trillion in the second quarter of this year, up $3.25 trillion, or 19%, from when inflation began soaring in the first quarter of 2021. according to Federal Reserve Data. 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 proven to be a major problem, but it is on track to become one.

The current debt delinquency rate is at 2.74%, the highest in nearly 12 years, although still slightly below the long-term average of around 3% in Fed data going back to 1987. However, a recent New York Fed investigation showed that the perceived likelihood of missing a minimum debt payment in the next three months jumped to 14.2% of respondents, the highest level since April 2020.

And it’s not just consumers who are accumulating credit.

Small business credit card usage continued to rise, up more than 20% from pre-pandemic levels and approaching the highest level in a decade, according to Bank of America. The bank’s economists expect the pressure to ease as the Fed lowers interest rates, although the extent of the cuts could be called into question if inflation proves persistent.

In fact, the only bright spot in the small business story when it comes to credit balances is that they haven’t kept up with inflation’s 23% increase since 2019, according to BofA.

Generally speaking, however, sentiment is pessimistic toward small businesses. The September survey from the National Federation of Independent Business showed that 23% of respondents still see inflation as their top issue, again the top issue among their members.

Amid the whirlwind of good and bad inflation news, the Fed has an important decision to make at its Nov. 6-7 policy meeting.

Since policymakers voted in September to lower their benchmark interest rate by half a percentage point, or 50 basis points, the markets acted curiously. Rather than anticipating a future rate cut, they began pointing to a higher trajectory.

The price on a Fixed mortgage over 30 yearsfor example, has climbed about 40 basis points since the decline, according to Freddie Mac. THE 10-year Treasury yield increased by a similar amount, and the 5-year equilibrium ratea bond market inflation gauge that measures the 5-year government’s impact relative to the inflation-protected Treasury security of the same duration, rose about a quarter point and recently hit its highest level since the beginning of July.

SMBC Nikko Securities was the only voice on Wall Street encouraging the Fed to pause its cuts until it can get more clarity on the current situation. The company’s position was as follows: stock prices Eclipsing new records as the Fed moved into easing mode, easing financial conditions threaten to push inflation higher. (Atlanta Fed President Raphael Bostic recently indicated that a November pause was a possibility he was considering.)

“For Fed policymakers, lower interest rates are likely to further ease financial conditions, boosting the wealth effect through rising stock prices. Meanwhile, a tight inflationary environment is expected to persist,” said SMBC chief economist Joseph LaVorgna, who was a senior economist under Donald Trump. Trump at the White House, wrote in a memo Friday.

That leaves people like the young man Daly, president of the San Francisco Fed, met with, worried about the future and suggesting the Fed may be 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 his speech in New York. “That is to say, I told the young father on the sidewalk my version of victory, and that is when I will consider the work accomplished.”