A customer shops for food at a grocery store on March 12, 2024 in San Rafael, California.
Justin Sullivan | News Getty Images | Getty Images
The last batch of inflation news Fed officials will see ahead of next week’s policy meeting is in, and none of it is very good.
Overall, Commerce Department indicators that the Fed relies on for inflation signals showed that prices continued to rise at a pace still significantly higher than the central bank’s annual target of 2 percent, according to separate reports this week.
Within this picture were several important points: The abundance of money that continues to be squeezed through the financial system gives consumers sustained purchasing power. In reality, buyers are spending more than they are taking in, a situation that is neither sustainable nor deflationary. Finally, consumers are dipping into savings to finance these purchases, creating a precarious scenario if not now then.
Put it all together, and that means a Fed is likely to be cautious and not in the mood to start cutting interest rates anytime soon.
“Spending a lot of money creates demand, creates incentives. With unemployment below 4%, it shouldn’t be surprising that prices aren’t falling,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. “The spending numbers aren’t going to come down anytime soon. So you might have a sticky inflation scenario.”
Indeed, its data The Bureau of Economic Analysis released Friday it said spending outpaced income in March, as it did in three of the past four months, while the personal savings rate fell to 3.2 percent, the lowest level since October 2022.
At the same time, the personal consumption expenditures price index, the Fed’s key gauge of inflationary pressures, rose to 2.7% in March when all items are included and held at 2.8% for the vital core measure that strips out more volatile food and energy prices.
A day earlier, the ministry said annual inflation in the first quarter was at a core rate of 3.7% in the first quarter overall and 3.4% overall. This came as real gross domestic product growth slowed to a 1.6% pace, well below the consensus estimate.
Risk scenarios
The persistent inflation data has raised several ominous specters, namely that the The Fed may have to keep interest rates high for longer than financial markets would like, threatening the expected economic soft landing.
There is an even more chilling threat that if inflation persists, central bankers may have to not only consider keeping interest rates where they are, but also consider future hikes.
βFor now, it means the Fed is not going to taper, and if [inflation] doesn’t fall, the Fed will either have to hike at some point or keep rates higher for longer,β said LaVorgna, chief economist at the National Economic Council under former President Donald Trump. “Does this finally give us the hard landing?”
The inflation problem in the US today first appeared in 2022 and had multiple sources.
At the start of the outbreak, the issues stemmed largely from supply chain disruptions that Fed officials believed would disappear once shippers and manufacturers had a chance to catch up as pandemic restrictions eased.
But even with the Covid financial crisis well in the rearview mirror, Congress and the Biden administration continue to spend lavishly, with the budget deficit at 6.2% of GDP at the end of 2023. This is the highest outside of the Covid years since in 2012 and a level generally associated with economic downturns, not expansions.
Additionally, a still tight labor market, in which jobs outnumbered available workers at one point by a 2-to-1 margin and are still around 1.4-to-1, also helped keep wage pressures down.
Now, even as demand shifts from goods to services, inflation remains elevated and confounds the Fed’s efforts to slow demand.
Fed officials believed inflation would ease this year as housing costs eased. While most economists still expect an influx of supply to lower shelter-related prices, other areas have emerged.
For example, core services PCE inflation excluding housing β a relatively new facet in the inflation equation nicknamed “supercore” β has been running at an annualized rate of 5.6% over the past three months, according to Mike Sanders, head of fixed income at Madison Investments.
Demand, which the Fed’s rate hikes were supposed to dampen, remained strong, helping to boost inflation and signaling that the central bank may not have as much power as it thinks to slow the pace of price increases.
“If inflation remains higher, the Fed will be faced with the difficult choice of pushing the economy into recession, abandoning the soft landing scenario, or tolerating inflation above 2 percent,” Sanders said. “For us, accepting higher inflation is the more prudent option.”
Concerns about a hard landing
So far, the economy has managed to avoid wider damage from the inflation problem, although there are some notable cracks.
Credit delinquencies have reached their highest level in a decade and there is growing concern on Wall Street that more volatility lies ahead.
Inflation expectations are also on the rise, with the near term to be monitored University of Michigan Consumer Sentiment Survey showing one- and five-year inflation expectations at annualized rates of 3.2% and 3% respectively, the highest since November 2023.
JPMorgan Chase CEO Jamie Dimon this week wavered from calling the U.S. economic boom “unbelievable” on Wednesday in a letter to the Wall Street Journal, telling the Wall Street Journal he was concerned that all the government spending was creating inflation that was more intractable than what is currently appreciated.
“That’s driving a lot of that growth, and that’s going to have other consequences, probably down the road called inflation, which may not go away as people expect,” Dimon said. “So I’m looking at the range of possible outcomes. You can have that soft landing. I’m a little bit more concerned that it might not be as soft and inflation might not go exactly as people expect.”
Dimon estimated that markets are pricing in a 70% chance of a soft landing.
“I think it’s half,” he said.