Inflation Is Down - Should The Fed Sit Tight?

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 10, 2023

IN THIS ISSUE:

1. Inflation Falls – What Should Fed Do Now?

2. President Tries To Sell “Bidenomics” To Public

3. American Households In Bad Financial Shape

Overview – Inflation Falls – What Should Fed Do Now?

The Consumer Price Index which soared to near 10% in 2022 has since receded to 3.7% for the 12 months ended August. That’s a major drop, of course, but the CPI still remains well above the Fed’s stated target of 2%.

The question remains whether the Federal Reserve should continue to hike its short-term lending rate from 5.25-5.50% where it currently stands, or if the Fed should remain on “pause” at its next two policy meetings on November 1 and December 13?

Chart showing consumer price index dropping

The Fed says it expects to hike the rate one more time between now and the end of the year, but then it unexpectedly decided to pause at its last policy meeting on September 20. The central bank has raised its Fed Funds rate 12 times since this rate hiking cycle began in March 2022.

Over the last couple of months, there have been increasing calls in the financial markets for the Fed to stand pat on further interest rate hikes in the hopes of avoiding a recession this year and hopefully next.

Yet the economy is actually performing stronger than expected as we close out the year, with Gross Domestic Product rising at a 4.9% annual rate in the 3Q according to the Atlanta Fed. That’s better than almost anyone expected.

So, the Fed is indeed at a decision point juncture. Most Fed-watchers believe the central bank has a difficult choice to make just ahead. I look at it a little differently: all options are open and a mere quarter-point change in the interest rate just ahead won’t make much of a difference.

If I’m Fed Chairman Jerome Powell, I’m thinking: we can’t screw up very bad just ahead regardless what decision we make next. Not a bad position to be in. I’m not saying it’s not important what the Fed does next; I’m just saying it doesn’t matter much in the big scheme of things right now.

What matters most, in my opinion, is whether we can avoid a recession next year. At this point, I do NOT believe a recession is the most likely scenario for 2024. Things can always change, of course, but the economy looks to be in pretty good shape for next year from where I sit.

The biggest unknown I see looks to be the 2024 presidential election outcome. At this point it is very unclear if the Democrats will decide to go with Biden again or will opt for some younger candidate – and time is running out to make that decision.

On the Republican side, it looks increasingly like Donald Trump will be the nominee, and it remains to be seen if he can beat whoever the Democrats decide to go with. Whatever the outcome, that’s where most of the political energy will play out over the next year.

Doesn’t sound all that interesting, does it? No, not really, but that’s where we are.

President Tries To Sell “Bidenomics” To The Public

President Joe Biden continues to tour the country promoting the success of his “Bidenonomics” policies. Yet polls continue to show the American people are not buying it. Consumers complain that everything they buy costs more today, and this reduces their buying power.

While inflation has come down from near 10% last year to 3.7% as discussed above, most prices still remain at the sharply elevated levels reached last year. Yes, the rate of price increases has slowed, but prices have not come down in most cases.

And it’s not just hurting consumers which account for roughly 70% of Gross Domestic Product. It is also hurting small businesses. Small businesses account for 1.5 million new jobs annually and drive about 44% of the economic activity in the United States.

We can argue about whether Mr. Biden’s policies have been good or bad for the economy. Conservatives, of course, believe that his policies have been bad, and I would tend to agree. However, I would also point out that it could be a lot worse since the president has not been able to push through nearly all of his liberal agenda.

Liberals, on the other hand, argue that Biden’s policies don’t go far enough. Most favor higher taxes, more government regulation and more attention paid to issues like climate change, same sex marriage, transgender rights, guaranteed income, etc., etc.

Such a political divide is nothing new, of course. Such debates have played out for over a hundred years, and will continue long into our future. As always, it comes down to both sides expressing their concerns and voting accordingly. The political pendulum swings back and forth. Nothing new there.

Which brings us back to the presidential election next year. Most polls show the race between President Biden and Donald Trump to be neck-and-neck at this point. Of course, it remains to be seen if that will be the matchup – Biden v. Trump – or someone else on the Democrat side.

This gets us back to today’s question: Should the Fed continue to raise rates or remain on “pause.” Let’s look at some more numbers.

The Personal Consumption Expenditures Price Index (PCE), which is the government’s favorite inflation index, rose last month at an annualized rate of 4.72%. This seems fast at the outset – after all, the Fed is supposed to target 2% inflation. But the headline number is misleading, as it doesn’t filter out hyper-volatile food and energy prices.

We all know energy in particular is getting more expensive. Just from July to August, measured prices for gasoline and other energy products rose a whopping 10.21%. This reflects economic fundamentals (supply and demand) in petroleum and related markets. It’s a mistake to include these price effects in our inflation analysis.

Let’s look at the “core” PCE, which excludes food and energy. This was only up 1.74 percent annualized – significantly below the Fed’s target, and the slowest since autumn 2020. Broad-based price pressures are almost certainly easing. This is a good sign for workers and families, whose wages have been stretched thin by inflation.

This suggests the Fed would be fine to remain on pause and wait a few more months to see how it all turns out and if the economy can avoid a recession next year. My point continues to be it may not make much of a difference what the Fed decides next.

American Households In Bad Financial Shape

While the economy is humming along at a nice pace in the second half of this year (GDP up 4.9%), many American families are in bad financial shape. A recent Morning Consult survey which found that in the third quarter of this year only 46% of Americans could cover a $400 unexpected expense without going into debt.

That’s not the same as being $400 away from bankruptcy, but it’s still really bad. It shows how expenses as commonplace as a surprise car repair or a medical bill are forcing many American families into debt – at a time when interest rates are disturbingly high.

The Lending Club’s Paycheck-to-Paycheck Report for June confirms the Morning Consult survey. It found that a majority of Americans (54%) were living paycheck to paycheck. That includes 53% of consumers who earn $50,000 to $100,000 per year. So, this problem extends well beyond lower-income families, although it certainly hits you harder the less you have.

But what about personal savings? Americans received a lot of cash from the government during the pandemic. In fact, when Biden took office, Americans had $2.3 trillion in personal savings. That number shot up to $5.7 trillion following Biden’s March 2021 ironically named "American Rescue Plan."

But by June of this year, a mere 27 months later, personal saving had dropped by nearly $5 trillion to a much diminished $862 billion. WOW!

Again, it isn’t just lower-income Americans who have watched their savings diminish. According to a Bloomberg analysis, the average middle-class household has lost over $33,000 in real wealth in just the past year.

The situation is so bad that Americans are even draining their 401(k) plans to cover expenses. According to Bank of America’s analysis of its clients’ employee benefits programs (with a total of over 4 million plan participants), 36% more people drained their retirement accounts to make ends meet in the second quarter of 2023 as compared to the same period last year.

So, where did all that money go? Well, as discussed above, Bidenomics-induced inflation has driven the cost of living up – a lot. Let’s look at it in dollar terms, which is how most Americans experience inflation.

Exacerbating the problem, wage growth has failed to keep pace with inflation – increasing only 13% since Biden took office (versus nearly 17% for inflation). When you’re living paycheck to paycheck, as most Americans are, that kind of disparity hurts.

So, with savings increasingly depleted and wages failing to keep up with increased living expenses, many Americans are resorting to their credit cards in an effort to make ends meet. According to the Federal Reserve Bank of New York, in the second quarter of this year, credit card debt rose to $1 trillion – the highest number ever.

And that amount of credit card debt is a huge problem with 51% of Americans unable to pay off their entire balance each month – so they let it revolve to the next month at an average budget killing interest rate of 15% or more.

The Bottom Line: When you read that "Bidenomics is working," know that it’s not.

Best fall regards,

Gary D. Halbert

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