A family shops for Halloween candy at a Walmart Supercenter on October 16, 2024 in Austin, Texas.
Brandon Bell | Getty Images
Just because the Federal Reserve is nearing its inflation target doesn’t mean the problem is over, as the high price of goods and services across the U.S. economy continues to weigh on individuals, businesses and policymakers.
Recent reports on prices for goods and services, despite being slightly stronger than expected, show that the rate of inflation 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 later this month releases its data on the Fed’s favorite price measure, the inflation rate could be close enough to round down to that level. 2%.
But inflation is a patchwork. It cannot be fully captured by any single measure, and by many measures it is still well above where most Americans, and even some Fed officials, are comfortable.
Like many of her colleagues, San Francisco Fed President Mary Daly on Tuesday supported easing inflationary pressures, but noted that the Fed is not declaring victory or willing to rest on its laurels.
“Continued progress toward our goals is not guaranteed, so we must remain vigilant and purposeful,” he told a group gathered at New York University’s Stern School of Business.
Inflation is not dead
Daly began her speech with an anecdote of a recent encounter she had while walking near her home. A young man pushing a cart and walking a dog called out, “President Daley, are you declaring victory?” He assured him that he is not waving any banners when it comes to inflation.
But the debate cut across a dilemma for the Fed: If inflation is on the run, why are interest rates still so high? Conversely, if inflation hasn’t been whipped yet—those who were around in the 1970s may remember the “Whip Inflation Now” buttons—why is the Fed tapering at all?
As the young man’s question demonstrates, convincing people that inflation is subsiding is a difficult task.
When it comes to inflation, there are two things to remember: the inflation rate, which is the twelve-month view that grabs the headlines, and the cumulative effect that a three-plus year period has had on the economy.
Looking at the 12-month price only provides a limited view.
The annual rate of CPI inflation 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 focus, but is secondary to the Fed, which prefers the personal consumption expenditure price index. Department of Commerce. Taking the data from the CPI that feeds the PCE measure led Goldman to conclude that the latest measurement is just a few hundredths of a percentage point short of 2%.
Inflation first surpassed the Fed’s 2% target in March 2021 and for months was dismissed by Fed officials as the “transient” product of pandemic-specific factors that would soon recede. Fed Chairman Jerome Powell, in his annual policy address at the Jackson Hole Summit in Wyoming this August, joked about “the good ship Transitory” and all the passengers it had in the early days of inflation.
Obviously, inflation was not temporary and the all-items CPI reading has risen by 18.8% since then. Food inflation increased by 22%. Eggs increased by 87%, car insurance it has shot up almost 47% and gasoline, although on a downward trajectory these days, is still up 16% since then. And, of course, there is housing: The average house price it has jumped 16% since Q1 2021 and 30% since the beginning of the pandemic-fueled buying frenzy.
Finally, while some headline measures of inflation, such as CPI and PCE, are easing, others are showing stubbornness.
For example, the Atlanta Fed measure “sticky price” Inflation — think rent, insurance and medical care — was still running at 4% in September, even as the “flexible CPI,” which includes the cost of food, energy and vehicles, was in full deflation at – 2.1%. This means prices that don’t change much are still high, while those that do, in this particular case gasoline, are falling but could turn in the opposite direction.
The constant price measure also highlights another important point: “core” inflation that excludes food and energy prices, which fluctuate more than other items, stood at 3.3% in September from the CPI measure and in 2.7% in August as measured by the PCE Index.
While Fed officials have recently been talking more about securities, they have historically viewed the core as a better gauge of longer-term trends. This makes the inflation figures even more disturbing.
Borrowing to pay higher prices
Before the 2021 spike, American consumers were used to negligible inflation. Even so, during the current run, they continued to spend, spend, and spend some more despite grumblings about the rising cost of living.
In the second quarter, Consumer spending reached $20 trillion at an annual rate, according to the Bureau of Economic Analysis. In September, retail sales rose by a more-than-expected 0.4%, with the group that directly feeds into gross domestic product calculations rising 0.7%. However, year-on-year spending rose just 1.7%, below the CPI inflation rate of 2.4%.
An increasing portion of spending has been through IOUs of various forms.
Household debt totaled $20.2 trillion in the second quarter of this year, up $3.25 trillion, or 19%, since inflation started to pick up 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, mounting debt hasn’t proven to be a major problem, but it’s getting there.
The current delinquency rate is at 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 recent New York Fed survey showed 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 credits.
Small business credit card usage continued to be higher, up more than 20% from pre-pandemic levels and nearing a decade high, according to Bank of America. Economists at the bank expect pressure to ease as the Fed cuts interest rates, although the size of the cuts could be called into question if inflation proves sticky.
In fact, the only bright spot in the story of small business credit balances is that they haven’t actually kept up with the 23% increase in inflation since 2019, according to BofA.
In general, however, the climate is negative for small businesses. The September survey by the National Federation of Independent Business found that 23% of respondents still see inflation as the main problem, again the top issue for members.
The choice of the Fed
Amid the swirling currents of the good news/bad news inflation picture, the Fed has an important decision to make at its November 6-7 policy meeting.
Since policymakers in September voted to cut their key interest rate by half a percentage point, or 50 basis points, markets reacted curiously. Instead of the price at lower prices ahead, they have started to show a higher trajectory.
The percentage in a 30 year fixed mortgagefor example, is up about 40 basis points since the cut, according to Freddie Mac. THE 10-year bond yield has increased by a similar amount, and the 5 year breakeven ratea bond market inflation index that measures the 5-year Treasury bill against the same-term Treasury Protected by inflation, rose by about a quarter and was recently at its highest level since early July.
SMBC Nikko Securities has been a lone voice on Wall Street encouraging the Fed to take a break from cutting until it has more clarity on the current situation. The firm’s position was that with stock market prices eclipsing new records as the Fed moved into easing mode, easing financial conditions threatened to push inflation back up. (Atlanta Fed President Rafael Bostic recently said a November pause is a possibility he is considering.)
“For Fed policymakers, lower interest rates are likely to further ease financial conditions, thereby amplifying the wealth effect through higher stock prices. Meanwhile, a highly inflationary environment should persist,” the chief economist SMBC’s Joseph LaVorgna, who was a senior economist in Donald Trump’s White House, wrote in a memo Friday.
That leaves people like the young man Daly, the president of the San Francisco Fed, met with worried about the future and hinting that the Fed might be making a policy mistake.
“I think we can move forward [a world] where people have time to catch up and then catch up,” Daly said during her speech in New York. “So, I told the young father on the sidewalk, my version of victory, and then I’ll consider the job done. “