— Scott B. MacDonald, Chief Economist
Favorable CPI Report, But It’s Still Not Easy Being the Fed
The April 2024 CPI report was met by a sigh of relief at the Fed and revived Wall Street calls for an interest rate cut in September, which was received as good news at the Biden White House. Indeed, April’s CPI, which came in at 3.4% (year-on-year), was a step down from March’s 3.5% CPI. The lower CPI print gives credence to the contention that the U.S. central bank’s restrictive monetary policies are driving inflation toward its stated 2.0% target. Softer retail numbers supported the dip in CPI. Although stocks rose on the news with the view that rate cuts are coming (now with two cuts priced in by December), we think it is too early to take a victory lap. Our view remains skeptical of a rash of Fed cuts and believe inflation will remain sticky so most Americans are going to feel the sting of higher prices through much of 2024.
Simply stated, the U.S. economy still has considerable momentum. Chances of inflationary upticks remain a possibility, and if China and the U.S. slide into a deeper tariff war, additional inflationary pressures could surface.
Whence Inflation and Whither CPI?
While April’s CPI number indicated that inflation is heading down, the question remains to be answered if the decline is sustainable? Reaching the 2.0% target is going to be tough. The Fed is increasingly boxed in – cut too early and inflation bounces back, hurting Fed credibility – again. Cutting too late could push an economic slowdown into a recession. The problem for the Fed is that despite some signs of moderation, the economy continues to move along at a brisk pace. The most recent Atlanta Fed “nowcast” (a rolling forecast that incorporates new data as it is released) was upgraded to 4.2% (as of May 8th), from a little over 2.0% in early April. This would be an improvement over Q1, 2024’s real GDP of 1.6%. Retail sales factor large here.
April’s retail prices were roughly flat at 3.0%. Consumers continue to spend despite rising credit card debt and high interest rates. What is significant is that consumers are still spending on essentials even while they pare their purchases on luxuries and higher prices. This makes the direction of wages and employment even more important. According to the U.S. Bureau of Labor Statistics, in Q1 2024, wages and salaries increased 1.1%, still in positive territory. If growth continues, do wages see further upward traction? According to the Bank of America Institute, lower-income spending growth remains above that of higher-income households in April. It did, however, caution that “the apparent cooling in labor markets warrants close watching from here.” We concur with that view.
Despite the better news on the CPI front, inflation remains a hot button for most Americans. According to the Bureau of Labor Statistics, rent and gasoline prices accounted for a whopping 70% of the price rise in April, hitting home for most Americans. According to an April 2024 Gallup poll, when asked what is the most important financial problem facing your family today, 41% of Americans listed the high cost of living/inflation. This is up from 32% in April 2022 and 35% in April 2023.
There are ongoing political consequences for sticky inflation. According to a Rasmussen Reports (May 14, 2024), President Biden’s disapproval ratings are at 59%, largely due to concerns over the economy. This is also showing up in opinion polls, like those from NY Times/Siena (released on May 13th), that show the President behind his main opponent, Donald Trump, in practically every swing state, except Michigan. This also reflects a disconnect between Wall Street and Main Street (where most Americans live); the former is overly focused on interest rate cuts and the stock market, while the latter still sees high prices when going to the grocery store, eating out at the restaurant, and filling the automobile with gas.
The last takeaway from April’s CPI is that there are external factors that remain beyond the Fed’s control, including the Middle East, the Russo-Ukrainian War, and Taiwan and the South China Sea. Although Houthi attacks on Red Sea shipping have faded in the headlines, they are adding to inflationary pressures: one-third of all container traffic moves through the Red Sea as well as 12% of seaborne oil and 8% of LNG. Higher shipping costs related to geopolitical risk eventually get passed on to the consumer, something the Fed has little means with which to contend. This could also encompass the deepening trade war with China. While Biden claims that he is the most pro-labor union president in U.S. history, higher tariffs are likely to result in greater costs for American consumers. The push to go green runs into the complicating factor that most batteries used in the U.S. come from China as well as refined rare earth metals required for military uses and consumer goods. Pressure on this front could mount through the year and into 2025 as China responds to U.S. protectionism.
The bottom line - While Wall Street continues to hope for cuts in the near term, we are taking our cue from Chairman Powell’s May 14th comment that the U.S. central bank will have to be “patient and let restrictive policy do its work.” Considering ongoing pressure from housing prices (lack of supply), ongoing high oil prices (which on May 16, 2023, were at $67.93 and are now $79.14), rising demand for electricity power generation and the upward push from wages, inflation does not appear ready to quietly slip below 3.0% any time soon. The U.S. economy still has considerable growth momentum, something the Fed will continue to wrestle with through the rest of 2024. Considering the flow of economic data, much of it is still contradictory, it is not easy being the Fed.
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