A grocery cart sits in an aisle of a grocery store in Washington, DC on February 15, 2023.
Stefani Reynolds | AFP | Getty Images
It was a year ago this month that the Federal Reserve launched its first attack on inflation that had been percolating through the US economy for at least the previous year.
This first move, in retrospect, would seem timid: Just quarter percentage point increase to cope with price spikes which, in just a few months, would reach their highest annual rate since late 1981. It wouldn’t be long before policymakers knew that the first step wouldn’t be enough.
The following months saw much larger increases, enough to raise the Fed’s benchmark borrowing rate by 4.5 percentage points to its highest level since 2007.
So, after a year of fighting inflation, how are things going?
In short, OK, but not much more.
The rate hikes appear to have snuffed out some of the surge in inflation that inspired the policy tightening. But the idea that the Fed was too late to start persists, and questions are mounting about how long it will take the central bank to return to its 2% inflation norm.
“They have a long way to go,” said Quincy Krosby, chief global strategist for LPL Financial. “It took them a long time to recognize that inflation was more rigid than they had initially estimated.”
Indeed, Fed officials for months stuck to the narrative that inflation was “transientand would subside on its own. In the meantime, prices soared, wages rose but failed to keep up, and central bankers got the public impression they were asleep. at the switch as an economic crisis raged.
A Gallup poll end of 2022 showed that only 37% of the public had a favorable impression of the Fed, which not long ago was one of the most trusted public agencies.
“It’s not to criticize them, but to understand: they don’t know any more about inflation than the average consumer. That’s important,” Krosby said. “It’s just, it’s their job to know. And that’s where the critics come in.”
This criticism came amid staggering inflation data.
Energy prices at one point last summer were up more than 41% within a 12 month period. Food inflation peaked at over 11%. Prices for individual items such as eggs, airline tickets and pet food have seen stratospheric increases.
Fed Chairman Jerome Powell recently insisted that he and his colleagues were now taking “strong action” to bring down inflation. Powell and other Fed officials have almost universally acknowledged that they have been slow to acknowledge the sustainability of inflation, but they are acting appropriately to fix the problem now.
“It would be very premature to declare victory or to think that we have really understood,” Powell added during a February 1 press conference. “Our goal, of course, is to bring inflation down.”
Some signs of progress
Inflation is a mosaic of many indicators. At least recently, there have been signs that one of the most closely watched indicators, that of the Labor Department consumer price index, at least goes in the right direction. The index recently showed an annual inflation rate of 6.4%, down from a peak of around 9% in the summer of 2022.
THE personal consumption expenditure price indexwhich is more closely watched by the Fed as it adapts more quickly to swings in consumer behavior, has also fallen, to 5.4% annually, and is approaching the CPI.
But with inflation still well above the Fed’s target, financial markets are increasingly concerned that more interest rate hikes are needed, even more than central bank officials expect. In recent months, the Federal Open Market Committee responsible for setting rates has reduced the level of rate hikes, from four consecutive three-quarter point increases to a half-point hike in December and a move by a quarter of a point at the start of February.
“They slowed down [the pace of hikes] prematurely. We are only at the starting gate of their biting policy measures,” said Steven Blitz, chief US economist at TS Lombard. get rates where they would. even start biting.”
Another big market fear is that the Fed will cause a recession with its rate hikes, which have brought the benchmark overnight borrowing rate into a range between 4.5% and 4.75%. Markets believe the Fed will raise that rate to a range between 5.25% and 5.5% before stopping, according to futures trading data.
But Blitz said a mild recession could be the best case scenario.
“If we don’t get a recession, we’ll be at a 6% funding rate by the end of the year,” he said. “If we get a recession…we’ll be in a 3% funding rate by the end of it.”
So far, however, a recession doesn’t seem like a near-term threat at all. The Atlanta Fed is gross domestic product tracking 2.3% growth in the first quarter, just ahead of the 2.7% level in the fourth quarter of 2022.
The Fed’s actions have hit the most rate-sensitive sectors of the economy the hardest. Housing retreated from its nosebleed heights at the start of the Covid pandemic, while Silicon Valley was also hammered by higher costs and pushed into a painful series of layoffs after over-hiring.
But the labor market as a whole has been incredibly resilient, posting an unemployment rate of 3.4% which is tied for the lowest since 1953, after a burst in January that saw non-agricultural payroll increases by 517,000.
The wide gap between job openings and available workers is one reason economists believe the United States could avoid a recession this year.
There are flashpoints, however: While housing is mired in a prolonged slump, manufacturing has been contracting for the past three months. These conditions are in accordance with what some economists have called “rolling recessions” in which the economy as a whole does not contract, but individual sectors do.
Consumers, however, remain strong, with retail sales jump 3% in January, as shoppers put their accumulated savings to good use, keeping restaurants and bars full and boosting online sales.
While this is good news for those who want to see the economy strong, it’s not necessarily nice for a Fed that is deliberately trying to slow the economy so it can get inflation under control.
Citigroup economist Andrew Hollenhorst thinks the Fed could bring key inflation indicators under control to around 4% by the end of this year. It would be better than the last Core CPI of 5.6% and base PCE of 4.7%, but still well off target.
Recent stronger-than-expected readings for both gauges show the risk is on the upside, he added.
A cut “should allow Fed officials enough focus on the slowing economy to reduce inflationary pressure,” Hollenhorst wrote in a client note this week. “But the activity data isn’t cooperating either.”
Goldman Sachs is also confident that inflation will fall over the next month. But “but some news from the past month has made the near-term outlook more difficult,” wrote Goldman economist Ronnie Walker.
Walker notes that commodity prices for items such as used cars have risen rapidly. He also estimated that “super-core” inflation — a measure President Powell has spoken of recently that excludes food, energy and housing costs — will likely stay around 4%.
Taken together, the data suggests that “the balance of risks to our forecast” for the Fed’s key interest rate is “tilted to the upside,” Walker wrote.
More flexible conditions
A disconcerting part of the Fed’s efforts is that policy measures are meant to work through “financial conditions” — an amalgamation of indicators covering everything from bond yield spreads and stock market movements to mortgage rates and interest rates. other much more obscure measures.
The Chicago Fed has a tracker that provides a good gauge of where things are headed. Interestingly, even though the Fed has continued to tighten policy, the Chicago index has actually eased since October, helping to illustrate the challenge of calibrating policy with conditions on the ground. (Measurements above zero represent tighter, while those below zero show looser conditions.)
This is particularly disconcerting given that Powell said at the Feb. 1 press conference that conditions “have tightened very significantly” since the rate hikes began.
Despite struggles to alter the flow of inflation, Minneapolis Fed Chairman Neel Kashkari said Wednesday he saw evidence the policy was working.
However, he acknowledged that there was still work to be done.
“Real rates are positive across the curve, which suggests to me that our policy is having the desired effect of dampening the economy,” Kashkari said at an event in Sioux Falls, SD.
“But I’m aware, hey, if we declare victory too soon there will be this flood of exuberance and then we have to do even more work to roll that back,” he added. “So we’re going to keep doing what we’re doing until we’re done, and I’m committed to doing that.”