All the data shows that inflation is not going away, making things difficult for the Fed

The latest round of inflation information that Federal Reserve officials will see before their policy meeting next week is here, and none of it is very good.

Overall, the Commerce Department indices that the Fed relies on to gauge inflation signals show that prices continue to rise at a pace still well above the central bank’s 2% annual target. , according to separate reports this week.

In this table, several salient points stand out: the abundance of money that continues to circulate in the financial system gives consumers lasting purchasing power. In fact, shoppers are spending more than they earn, a situation that is neither sustainable nor disinflationary. Finally, consumers are dipping into their savings to finance their purchases, creating a precarious scenario, if not now, then later.

Put it all together and you get a Fed that is likely to be cautious and not in the mood to start cutting interest rates anytime soon.

“Just spending a lot of money creates demand, it creates stimulus. With unemployment below 4%, it shouldn’t be that 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 could have a tough inflation scenario.”

Indeed, data released Friday by the Bureau of Economic Analysis showed that spending exceeded income in March, as it has in three of the last four months, while the personal savings rate plunged at 3.2%, its lowest level since October 2022.

At the same time, the personal consumption expenditures price index, the Fed’s key measure of determining inflationary pressures, rose to 2.7% in March when including all items, and held steady at 2 .8% for the vital baseline measure which excludes the most volatile food and food items. energy prices.

A day earlier, the ministry announced that annualized inflation in the first quarter stood at an underlying rate of 3.7% for the entire first quarter and 3.4% on an overall basis. This came as real gross domestic product growth slowed to a pace of 1.6%, well below the consensus estimate.

The stubborn inflation data has raised several worrying specters that the Fed may have to keep rates high for longer than it or financial markets would like, threatening the hoped-for economic soft landing.

There’s an even scarier threat: If inflation actually persists, central bankers may have to consider not only keeping rates where they are, but also considering future hikes.

“For now, that means the Fed is not going to cut interest rates, and if (inflation) doesn’t come down, the Fed will either have to raise rates at some point or keep rates higher longer,” said LaVorgna, the Fed’s chief executive. economist at the National Economic Council under former President Donald Trump. “Does this ultimately bring us to a hard landing?”

The inflation problem in the United States today first emerged in 2022 and had multiple sources.

Early in the outbreak, the problems largely stemmed from supply chain disruptions that Fed officials said would disappear once shippers and manufacturers had a chance to catch up through the easing of pandemic restrictions.

But even with the Covid economic crisis well behind 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. That’s the highest in outside the Covid years since 2012. and a level generally associated with economic downturns and not expansions.

Additionally, a still-dynamic labor market, in which job openings at one point exceeded available workers by a ratio of 2 to 1 and still stand at around 1.4 to 1, has also helped maintain high wage pressures.

Today, even with a return of demand for goods to services, which corresponds to the normal state of the American economy, inflation remains high and thwarts the Fed’s efforts to slow demand.

Fed officials believed inflation would slow this year as housing costs fell. While most economists still expect an influx of supply to drive down housing prices, other areas have emerged.

For example, inflation in core non-housing PCE services – a relatively new issue in the so-called “supercore” inflation equation – has been running at an annualized rate of 5.6% over the past three years. month, according to Mike Sanders, head of fixed income at Madison Investments.

Demand, which the Fed’s rate hikes were supposed to suppress, has remained robust, helping to boost inflation and signaling that the central bank may not have as much power as it thinks to slow the pace of the rise in prices.

“If inflation remains high, the Fed will face a difficult choice: push the economy into a recession, abandon its soft landing scenario, or tolerate inflation above 2%,” Sanders said. “For us, accepting higher inflation is the most prudent option.”

So far, the economy has managed to avoid greater 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 unease on Wall Street about greater volatility to come.

Inflation expectations are also rising, with the closely watched University of Michigan Consumer Confidence Survey showing one- and five-year inflation expectations at annual rates of 3.2% and 3%, respectively. , their highest since November 2023.

From no less a source than JPMorgan Chase CEO Jamie Dimon this week vacillated between calling the U.S. economic boom “incredible” on Wednesday and writing a letter to the Wall Street Journal in which he worried that all government spending would create inflation that is more intractable than what is real. currently appreciated.

“That explains a lot of this growth, and it will eventually have other consequences in the future, called inflation, that may not go away like people expect,” Dimon said. “So I’m looking at the range of possible outcomes. You can have this soft landing. I’m a little more worried that it won’t be that soft and that inflation won’t play out quite the way people think. ‘wait.”

Dimon estimates that markets are pricing in a 70% chance of a soft landing.

“I think it’s half of it,” he said.