Home Economy Inflation Cools, Leaves America Asking: What’s Next?

Inflation Cools, Leaves America Asking: What’s Next?

by SuperiorInvest

Martin Bate, a 31-year-old transportation planner in Fort Worth, spent the middle of 2022 feeling like he was “treading water” as high gas prices, rising food costs and the prospect of big rent increases sapped his finances.

“I was really starting to feel financially stressed in a way I hadn’t felt since I had finished college,” Mr Bate said. He has since received a promotion and a 12 percent raise. Gas prices have dropped and local housing costs have eased enough that he’s moving next month to a nicer apartment that costs less per square foot than his current place.

“My personal situation has improved a lot,” Mr Bate said, explaining that he was feeling cautious but hopeful about the economy. “Looks like it might look good.

People across the country are finally experiencing some relief from the relentless rise in the cost of living. After repeated false dawns in 2021 and early 2022 – when price growth slowed only to pick up again – signs have begun to pile up that inflation is indeed turning around.

Inflation has slowed on an annualized basis for six straight months, falling to 6.5 percent after peaking around 9 percent last summer, in part because gas became cheaper. But the slowdown holds even after stripping out volatile food and fuel: so-called core consumer prices have risen 0.3 percent or less over the past three months. That’s faster than the 0.2% month-on-month change that was typical before the pandemic, but much slower than the 0.9% peak in April 2021.

America may have finally reached an inflation tipping point. The question now centers on what comes next.

Some economists expect inflation to remain stubbornly faster than before the pandemic, while others expect a sharp slowdown. Some assume something in between. Which prospect plays a big role: The speed and extent of cooling inflation will inform how high Federal Reserve policymakers raise rates, how long they keep them elevated and how much pain they inflict on the economy.

For now, the overwhelming uncertainty has Fed officials calling for further slowing — but not halting — rate hikes between Jan. 31 and Feb. 1 meeting. Officials pulled back from a previous three-quarter hike to a half-point move in December, and many support a rate hike of just a quarter point this time around. A more gradual approach would give policymakers a better chance to see how the economy has developed, reducing the risk of driving the economy off a cliff.

“If you’re on a road trip and encounter foggy weather or a dangerous highway, it’s a good idea to slow down,” Lorie Logan, president of the Federal Reserve Bank of Dallas, said during a speech last week. The same considerations that prompted central bankers to slow in December “point to a further slowdown in the coming session.”

Officials have just entered a quiet period ahead of talks, so remarks from Ms. Logan and her colleagues last week are the last investors will hear until then. Central bankers have warmly welcomed the recent slowdown in inflation – but said it was too early to declare victory and highlighted the huge uncertainty ahead.

Many economists and Fed officials themselves estimate that it will take years for inflation to return to the 2% annual rate that was once typical. But some on Wall Street think inflation could fall sharply, perhaps even returning to historically low levels that prevailed before the pandemic. A clear divide is visible: The top forecast in a Bloomberg survey of economists expects consumer price growth to remain at or above 5 percent through the end of 2023, while the lowest shows it slowing to 1.5 percent.

The Fed will receive more inflation data this week. The personal consumption expenditure index is expected to have risen 5 percent in December from a year earlier, up from 5.5 percent in November. This measure is related to the consumer price index inflation rate, but lags behind, and is the Fed’s official target.

While officials and economists try to figure out what will happen to inflation, the fate of ordinary Americans hangs in the balance. If the Fed slows the economy too much in an effort to control prices and causes a steeper recession than necessary, people will pay with their jobs.

But if continued rapid price increases erode wage gains and erode savings, it will get worse for households, too.

“I have to say, I’m worried about the future,” said Karen Loeb, a 71-year-old assistant professor of sociology in Amherst, Massachusetts. After tracking the prices of goods, she shopped at thrift stores and bakes her own challah. and food has skyrocketed over the past two years.

For people like Ms. Loeb, as well as for central bankers, there are key reasons to hope that inflation will moderate significantly in 2023.

Housing costs are still rising in official price data, but real-time rent trackers show a sharp slowdown in rental demand. Economists expect this to be reflected in inflation data in the coming months.

When it comes to cars, used – and more recently new – inventory is improving, which is already starting to drive down car prices. And prices for a wide range of other goods are slowing their rise or falling as transportation costs fall back to pre-pandemic levels and supply shortages ease.

While the rapid commodity inflation was driven by supply issues, it was also partly a function of strong demand: Consumer spending on household and other products has increased since 2020, in part as families took government stimulus payments and money they saved during the pandemic. lockout and spent it on renovations or camping gear. But the demand is there dwindling because savings are slowly eroding.

In addition, the Federal Reserve raised interest rates from near zero to above 4.25 percent last year, which could weigh on consumer spending and make it harder for firms to implement large price increases without putting off customers.

“It looks like a very long-term supply shock — to some extent a demand shock — that we’ve weathered,” said Omair Sharif, founder of Inflation Insights. “These things seem pretty clearly on the road to normalization.”

Encouragingly, prices for more than just a few types of goods or services are showing a slowdown. The share of product categories with inflation above 3 percent fell from nearly three-quarters at the start of 2022 to less than half in December, Fed Governor Christopher Waller said. he said in a speech last week.

But risks remain, as it is unclear whether the forces now pulling inflation down will be enough to quickly return prices to the 2 percent annual pace the Fed aims for.

Short-term volatility is likely. Mr. Sharif said the jump in the cost of medical care services, coupled with higher Medicare reimbursements, could even help to briefly pick up monthly inflation again in the coming months.

And the cost increase could also have a longer shelf life. Fed officials forecast that inflation, as measured by the personal consumption expenditure index, will still hover around 3.5 percent by the end of the year, with volatile food and fuel prices stripped out. stay high above 2 percent by 2024.

This perceived stubbornness ties back to a booming job market. With wages growing at an unusually fast pace as companies struggle to attract and retain workers, Fed policymakers believe firms may continue to raise prices to cover costs. Meanwhile, higher incomes will allow shoppers to continue to afford the things they want and need.

That’s why many central bankers expect to raise interest rates a bit more and then keep them high throughout 2023. Higher borrowing costs may discourage consumers from spending on credit and businesses from expanding, further cooling demand in economy and the labor market.

Wage growth is already showing some signs of slowing, and the Fed will receive more Job Cost Index report the day before the February 1 rate decision.

While other labor indicators were more resilient, Fed officials in their latest economic forecast predicted unemployment would rise to 4.6 percent by the end of the year from the current 3.5 percent.

While that would hurt some households, Fed officials still hope for a relatively soft landing. In light of recent inflation data, even Lawrence H. Summers, the Harvard economist and former Treasury secretary who warned that the economy could be headed for a sharp downturn, has raised America’s chances of avoiding a painful recession.

“Soft landings are triumphs of hope over experience, but sometimes hope trumps experience,” Summers said in an interview with Bloomberg Television last week.

But many investors think the U.S. economy will slow enough to slip into an outright recession in the coming months, forcing the Fed to cut rates before the end of the year.

Nobody really knows. Unexpected events—new developments in Ukraine, a painful debt ceiling that slows growth, or a new and unexpected spike in oil prices—could reverse the outlook for growth and inflation.

“The past few years have been absolutely flying blind for forecasters,” Mr Sharif said. “It’s slowly getting back to normal, but it’s still pretty hard.”

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