Worst inflation fears ease
Emma Loop
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After a year of historic economic turbulence and sky-high consumer prices, federal officials in Washington are starting to float a new word around: optimism.
The latest government data show that inflation, which has hiked the price of everyday goods and dogged President Joe Biden’s approval numbers, has continued to relent in recent months. That’s prompted a cautious but hopeful attitude among those shaping U.S. monetary policy.
ECONOMY GREW 2.1% IN 2022 AMID BARRAGE OF INTEREST RATE HIKES
“We have made progress,” Christopher Waller, a Federal Reserve governor, said in a recent speech. “Six months ago, when inflation was escalating, and economic output had flattened, I argued that a soft landing was still possible — that it was quite plausible to make progress on inflation without seriously damaging the labor market. So far, we have managed to do so, and I remain optimistic that this progress can continue.”
Biden has cheered the latest inflation figures as well, calling the most recent consumer price index, which measures how much consumers pay for everything from food to cars, “good news.” The CPI was 6.5% for the year ending in December, which despite still being high, was “the smallest 12-month increase since the period ending October 2021,” the Bureau of Labor Statistics reported on Jan. 12.
“We have more work to do, but we’re on the right track,” Biden told reporters that day. “We’re seeing bright spots across the country where great things are happening. Roads and bridges are being built. Factories are coming online. People back to work again. Families breathing a little bit easier.”
“That’s why I can honestly say — and you’ve heard me say this before, and I mean it from the bottom of my heart — I’ve never been more optimistic about America’s future than I am today,” the president said.
But Biden, officials at the Federal Reserve, and financial experts are hedging any economic optimism with warnings that inflation is not fully in the rearview mirror. The Fed, which launched a series of aggressive interest rate hikes last March to tackle soaring prices, is not yet ready to hit the brakes. “Back in 2021, we saw three consecutive months of relatively low readings of core inflation before it jumped back up,” Waller said. “We do not want to be head-faked.”
As it waits for more data showing that prices continue to decline, the Fed is expected to approve two more interest rate hikes at meetings in February and March — albeit smaller, at 0.25% each — then possibly pause the increases if all goes as planned. The U.S. central bank has already started to slow its efforts, approving an increase of 50 basis points in December after several months of historically high 75 basis point hikes, in large part due to consecutively lower inflation readings.
The current state of affairs suggests that as the new year begins, U.S. monetary policy has reached a possible transition point — one that both provides reassurance that consumers will continue to see some relief for their pocketbooks and indicates the likelihood of more pain in the shorter term.
With each interest rate hike, the Fed gets closer to tipping the United States into a recession, which would create major job losses at a time when many people have already depleted their savings or racked up credit card bills to keep up with soaring prices. The risks underline the delicate balance the central bank must strike as it tries to beat back record-high inflation. Already, economic activity has slowed, and it is expected to dip further in 2023.
“The almost 500bp of expected cumulative hikes is already delivering a commensurate tightening of financial conditions, which we believe will tip the economy into a mild recession later next year,” Jay Barry, co-head of U.S. rates strategy at JPMorgan, said in the firm’s 2023 Market Outlook. “With a slowing in aggregate demand, we project the unemployment rate will rise to 4.3% by the end of next year.”
In its economic forecast, the Conference Board predicts “that economic weakness will intensify and spread more widely throughout the U.S. economy over the coming months, leading to a recession starting in early 2023.”
“This outlook is associated with persistent inflation and the Federal Reserve becoming more hawkish,” the group said on Jan. 10. “We forecast that real GDP growth will be 2.0 percent year-over-year in 2022, slow to 0.2 percent in 2023, and then rebound to 1.7 percent in 2024.”
The Conference Board said it expects negative GDP growth in the first three quarters of this year, but that the downturn “will be relatively mild and brief, and growth should rebound in 2024 as inflation ebbs further and the Fed begins to loosen monetary policy.”
“While easing supply-side constraints and a more hawkish monetary policy are cooling inflation, rising interest rates will tip the U.S. economy into a broad-based recession,” the group said. “This contraction will impact extremely tight labor markets and drive the unemployment rate higher. Still we anticipate the jobless rate may peak at 4.5 percent, which by historical standards is quite low.”
Still, the specter of job losses has prompted criticism of the Fed’s plans, particularly from some progressives, who say it threatens to punish workers.
“Fed Chair [Jerome] Powell should remember the Fed’s dual mandate: fight inflation and protect jobs,” Sen. Elizabeth Warren (D-MA) tweeted on Jan. 13. “Inflation is slowing, but millions of Americans are at risk of losing their jobs if the Fed keeps up with its extreme interest rate hikes.”
Powell, however, has warned that the Fed will stay the course, regardless of how unpopular it might be. “Price stability is the bedrock of a healthy economy and provides the public with immeasurable benefits over time,” he said in a speech on Jan. 10. “But restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy. The absence of direct political control over our decisions allows us to take these necessary measures without considering short-term political factors.”
The December consumer price report showed that falling gas prices, which reached record peaks last spring amid supply chain problems and Russia’s invasion of Ukraine, have contributed the most price decreases, “more than offsetting” rental and housing prices, which remain stubbornly elevated despite early signs of a market correction.
“Indexes which increased in December include the shelter, household furnishings and operations, motor vehicle insurance, recreation, and apparel indexes,” the Bureau of Labor Statistics said. “The indexes for used cars and trucks, and airline fares were among those that decreased over the month.”
Lower gas prices also helped bring down the producer price index, which tracks wholesale prices, in December, the BLS said. For the year, headline PPI was at 6.2% — the lowest it’s been since March 2021. Meanwhile, the PPI was down 0.5% on a monthly basis, the biggest drop since April 2020.
“Inflation has declined in recent months from very high levels,” Fed Vice Chairwoman Lael Brainard said in a Jan. 19 speech at the University of Chicago Booth School of Business. “With the consumer price index and producer price index now available, total PCE (personal consumption expenditures) inflation in December is likely to have run at around a 2.3% annualized pace on a 3- and 6-month basis, as compared with 5.1% on a 12-month basis. This deceleration reflects an easing in war-related energy shocks as well as in core goods inflation: Energy and core goods each subtracted nearly three-fourths of 1 percentage point from 3-month annualized total PCE inflation.”
“Core PCE inflation is running at a 3.1% annualized pace on a 3-month basis — below its 3.8% reading on a 6-month basis and 4.5% on a 12-month basis. Within this, recent declines in core goods inflation reflect a reduction in core import prices, an easing of supply chains, a restocking of inventories, and cooling demand,” she added.
Brainard noted that inflation for housing services “remains stubbornly high at 8.8% on a 3-month basis — compared with 7.7% on a 12-month basis.” But she and other experts predict that will soon change. “Market rents and housing prices were soaring in 2021 and early 2022, but the trend has reversed in recent months,” according to Preston Caldwell, chief U.S. economist at Morningstar, who said the most recent CPI report “provides further evidence that inflation is normalizing.”
Brainard said, “The housing sector is highly interest-sensitive, and the most recent reading of one national indicator pointed to house prices having declined 2.5% over the five months ending in November.”
“Similarly, rents based on new leases are decelerating sharply,” she said. “Although it is currently offset by a catch-up in renewing leases, the decline in rent on new leases will show through to average rent over time, and declines in housing services inflation are expected by the third quarter of this year.”
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But like others, Brainard expressed the need for continued caution, despite the positive signs, as “substantial uncertainty remains.” She said additional “shocks” related to the Russian invasion of Ukraine, which resulted in major disruptions to energy markets, and the COVID-19 pandemic could still lie ahead.
“Turning to the implications for policy, my colleagues and I are committed to restoring price stability,” she said. “Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2% on a sustained basis.”