A family shops for Halloween candy at a Walmart Supercenter in Austin, Texas, on October 16, 2024.
Brandon Bell | Getty Images
Just because the Federal Reserve is moving toward its inflation target does not mean the problem is solved, as high prices for goods and services across the U.S. economy continue to place a burden on individuals, businesses and policymakers.
The latest price reports for goods and services, while slightly higher than expected, suggest that the inflation rate has moved closer to the central bank's 2 percent target over the past year.
In fact, Goldman Sachs recently estimated that when the Bureau of Economic Analysis releases its numbers on the Fed's most popular price measure later this month, the inflation rate could be close enough to be rounded down to the 2 percent level.
But inflation is a mosaic. It cannot be fully captured by any single measure, and on many measures it is still well above the level at which most Americans and even some Fed officials feel comfortable.
San Francisco Fed President Mary Daly echoed many of her colleagues last Tuesday, touting the easing of inflationary pressures but noting that the Fed is neither declaring victory nor ready to rest on its laurels.
“Continuous progress toward our goals is not guaranteed, so we must remain vigilant and determined,” 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 Daly, are you declaring victory?” She assured him that she was not waving banners on inflation.
But the conversation highlighted a dilemma for the Fed: If inflation is on the rise, why are interest rates still so high? Conversely, if inflation still hasn't been contained – those who were around in the 1970s may remember the “Whip Inflation Now” buttons – then why is the Fed cutting at all?
In Daly's eyes, 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, which is at the same time far from its mid-2022 peak, showing signs of that the labor market is becoming weaker.
As the young man's question shows, it is difficult to convince people that inflation is going down.
When it comes to inflation, there are two things to consider: the inflation rate, the 12-month view that grabs the headlines, and the cumulative impact that a three-plus-year period has had on the economy.
Looking at the 12-month rate only provides a limited overview.
The annual CPI inflation rate was 2.4% in September, a huge improvement from the peak of 9.1% in June 2022. The CPI measure attracts most of the public attention, but is secondary to the Fed, which prefers the price index for personal consumption expenditures Department of Commerce. Taking into account the inputs from the CPI that go into the PCE measure led Goldman to conclude that the latter measure is only a few hundredths of a percentage point away from 2%.
Inflation first exceeded the Fed's 2 percent target in March 2021 and was dismissed by Fed officials for months as a “transitory” product of pandemic-specific factors that would soon subside. Fed Chairman Jerome Powell joked about “the good ship Transitory” and all the passengers it carried in the early days of the inflation rise in his annual monetary policy speech at the Jackson Hole, Wyoming summit in August this year.
Clearly the inflation was not temporary and the overall CPI value has since increased by 18.8%. Food inflation is up 22%. Eggs are up 87%, car insurance is up almost 47% and gas, although currently on a downward trend, is still up 16% compared to then. And of course there is also housing: the average house price has risen by 16% since the first quarter of 2021 and by 30% since the pandemic-related buying spree began.
Finally, while some broad inflation indicators such as CPI and PCE are declining, others are showing persistence.
For example, the Atlanta Fed's measure of “sticky price” inflation — rent, insurance and medical care — was still at 4% in September, even as the “flexible CPI,” which includes food, energy and vehicle costs, was implemented outright deflation at -2.1%. This means that the prices that don't change much are still high, while the prices that do, in this particular case gasoline, are falling but could turn in the other 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 measure, and in August at 2.7% measured on the PCE index.
While Fed officials have been talking more about headlines lately, they have historically viewed core bonds as a better gauge of long-term trends. This makes the inflation data even more problematic.
Borrowing to pay higher prices
Before the 2021 surge, American consumers had become accustomed to negligible inflation. Yet in the current phase they have continued to spend, spend and spend some more, despite all the grumbling about the rising cost of living.
According to the Bureau of Economic Analysis, consumer spending in the second quarter was nearly $20 trillion on an annualized basis. In September, retail sales rose more than expected, rising 0.4%, with the group that goes directly into gross domestic product calculations rising 0.7%. However, spending rose only 1.7% year-on-year, which is below the CPI inflation rate of 2.4%.
A growing proportion of expenditure is carried out via promissory notes of various forms.
According to Federal Reserve data, household debt was $20.2 trillion in the second quarter of this year, an increase of $3.25 trillion, or 19%, from when inflation was in the first quarter of 2021 began to rise. In the second quarter of this year, household debt rose 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 achieving its goal.
The current debt default rate is 2.74%, the highest in nearly 12 years, but still slightly below the long-term average of about 3% in Fed data going back to 1987. However, a recent New York Fed survey showed that the perceived likelihood of missing a minimum payment in the next three months rose to 14.2% of respondents, the highest since April 2020.
And it's not just consumers who take out loans.
Bank of America says small business credit card usage continues to rise, up more than 20% compared to pre-pandemic levels and nearing its highest level in a decade. The bank's economists expect the pressure could ease if the Fed cuts interest rates. However, the extent of the cuts could be called into question if inflation proves stubborn.
In fact, the only bright spot in the small business story when it comes to loan balances is that they actually haven't kept pace with the 23% increase in inflation since 2019, according to BofA.
However, overall sentiment among small businesses is negative. The September survey by the National Federation of Independent Business found that 23% of respondents still see inflation as their top problem, again the top issue for members.
The Fed's decision
Amid the swirling currents of good and bad news on inflation, the Fed has an important decision to make at its policy meeting on November 6th and 7th.
Since policymakers voted in September to cut their key interest rate by half a percentage point, or 50 basis points, markets have reacted curiously. Instead of pricing in lower interest rates in the future, they have started to suggest a higher rate.
For example, according to Freddie Mac, the interest rate on a 30-year fixed mortgage has increased by about 40 basis points since the cut. The Yield on 10-year government bonds has risen by a similar amount, and the 5-year breakeven rate, a measure of bond market inflation that measures the 5-year Treasury bond compared to the Treasury Inflation Protected Security of the same maturity, has risen by about a quarter point and This value was recently at its highest level since the beginning of July.
SMBC Nikko Securities was a lone voice on Wall Street, calling on the Fed to pause interest rate cuts until more clarity can be gained on the current situation. The company argues that with stock prices hitting new records as the Fed has moved into easing mode, weaker financial conditions could push inflation higher again. (Atlanta Fed President Raphael Bostic recently indicated he was considering a pause in November.)
“For Fed policymakers, lower interest rates are likely to further ease financial conditions, thereby amplifying the wealth effect through higher stock prices. Meanwhile, a tight inflation backdrop should continue,” said SMBC chief economist Joseph LaVorgna, who was lead economist at Donald Trump’s White House, wrote in a note on Friday.
That's leading people like the young man Daly, the San Francisco Fed president, met to worry about the future and suggest whether the Fed might be making a policy mistake.
“I think we can move on [a world] where people have time to catch up and then move forward,” Daly said during her talk in New York. “That is, I told the young father on the sidewalk my version of victory, and then I will consider the job done.” “
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