Since late 2023, the U.S. economy has appeared to be sailing towards a recovery, with the GDP rebounding and the labor market seemingly on the mend. After clawing back from the pandemic-induced downturn and the multi-decade high inflation that ensued, media outlets have been abuzz with talk of a “soft landing” — something that seemed like a distant fantasy just a year ago.
However, cracks have begun to emerge in this rosy recovery narrative, with inflationary pressures mounting and the Federal Reserve struggling to find the right balance between supporting economic growth and containing price increases. According to a recent poll in swing states, 74% of Americans now believe that inflation has worsened over the past year. This growing concern is reflected in the Fed’s own estimates, which have been revised upward multiple times this year. With the central bank’s dual mandate of full employment and price stability in jeopardy, experts are divided on whether the Fed can engineer a smooth landing or if we’re in for a bumpy ride ahead.
A Closer Look into March’s Inflation Data
The latest inflation figures released by the Bureau of Labor Statistics (BLS) in March isn’t helping to ease the concerns of those fearing a bumpy ride. According to the report, consumer prices rose by 3.5% on a year-over-year basis, outpacing the 3.2% increase observed in February and exceeding the 3.4% forecast by economists. The highest annual gain in half a year, the surge in prices marks the third consecutive month of accelerating inflation, putting an end to the disinflation narrative that has been pushed by news outlets for months.
The BLS report highlighted that more than half of the monthly uptick in the CPI was attributed to the rising costs of gas and shelter. But even core inflation, which excludes volatile food and energy prices, came in hotter than expected, rising 3.8% on an annual basis. With the exception of a select few categories such as used and new cars — which saw price declines, or grocery store food prices, which remained stable — nearly every other category witnessed price hikes last month.
Due to the Fed’s focus on core inflation figures, which are less influenced by short-term price volatility, analysts are concerned that the central bank may be forced to postpone its plans to cut rates. “Inflationary pressures remain firm across the board,” said Blerina Uruçi, chief economist with T. Rowe Price. Inflation is “firmer than the Fed needs it to be to initiate a series of interest rate cuts anytime soon,” Uruçi added.
Amidst this backdrop of persistent inflationary pressures, the conversation among economists and Federal Reserve officials is shifting. The initial optimism for a reduction in interest rates is now tempered by a reality where further rate increases could even be on the horizon. In a recent speech, Fed Governor Michelle Bowman acknowledged the ongoing risk of inflation not only stalling but potentially reversing, suggesting further hikes in the policy rate may be necessary to maintain economic stability.
“I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” said Bowman. This shift in tone is a stark contrast from just a few months ago, when the Fed was signaling that interest rate cuts were more likely than increases.
Assessing Inflation Risks
As inflation continues to be a concern for the Federal Reserve, several factors are being evaluated to determine the best course of action. According to Bowman, much of the progress made towards curbing inflation last year was due to supply chain improvements and temporary factors such as the drop in oil prices. A massive uptick in immigration also brought in a large influx of workers, driving down wages in the process. However, with these temporary supports potentially fading away, Bowman warns inflation could begin to creep back up.
Already, we’ve seen supply chain pressures remerging amid ongoing conflicts in the Red Sea and the Suez Canal, as well as the recent collapse of the Key bridge that halted traffic on one of the busiest trade routes in the US. And with the Panama Canal Authority still limiting daily traffic to one of the world’s busiest waterways, there are concerns that the global supply chain may continue to face bottlenecks, leading to higher prices for consumers.
Apart from supply-side factors, geopolitical tensions remain a wildcard in the inflation equation. The uncertainty surrounding these issues make it difficult for businesses to plan and invest, which experts say could lead to potential price increases for consumers. With the ongoing conflict in Ukraine showing no signs of abating and tensions in the Middle East on the rise, the potential for further trade disruptions and increased costs for businesses is a major concern.
Bowman and others also cite “upside risks to housing services inflation,” driven by low inventory and high demand for housing as the number of immigrants continues to rise. If supply can’t keep up with demand, it could lead to an increase in rent and housing prices. With shelter constituting nearly a third of the Consumer Price Index (CPI) inflation basket and 40 percent of the core CPI, even minor upticks in rent and housing prices could impact the broader inflation measurements. The ongoing housing affordability crisis in many parts of the country only adds to these concerns.
And then there is the inflationary risk stemming from increased fiscal stimulus from both existing and newly approved appropriations. In what many political pundits claim is a last ditch effort to revive President Biden’s approval ratings, the White House recently announced the cancellation of an additional $7.4 billion in student loan debt. As part of a broader strategy to appeal to younger voters, the Biden administration has announced plans to discharge $153 billion in student loan debt for some 4.3 million borrowers. While this move and other proposed spending initiatives may have short-term positive impacts, it also carries the potential for long-term inflationary risks.
For Bowman and a growing number of economists, the key concern is not just that inflation may spike temporarily, but rather it could become a long-term problem. With the current levels of government spending and debt, there may come a point where the Fed’s traditional tools for controlling inflation, such as raising interest rates, may not be enough. And if inflation continues to rise, it could lead to a vicious cycle of increasing interest rates and debt repayment costs, potentially crippling the economy and burdening future generations with even more debt.
Analysts Expecting Rates Higher for Longer
March’s inflation report had been anxiously awaited by both economists and market participants, who were eager to see what clues it could provide about the path of future inflation. Since the start of the year, expectations had been high, with analysts predicting that the Fed could begin cutting interest rates as early as the first quarter. Markets also began to price-in the likelihood of these cuts, with the probability of a rate cut happening by March reaching as high as 81% in January. However, persistently high inflation dampened these hopes. The seasonal inflation increases that market forecasters were convinced would fade away in the early months of 2024 have continued to persist month after month, prompting the Fed to hold off on rate cuts.
With the latest CPI data and market reactions, there’s a shifting sentiment regarding the Federal Reserve’s interest rate policy. Initially anticipated cuts have now been delayed until July or later, with some speculating that 2024 might not witness any rate reductions. This adjustment in expectations comes despite earlier Federal Open Market Committee (FOMC) projections, made before the March CPI release, which hinted at three cuts in 2024. While the committee has historically been quick to reduce rates once their final rate hike has been completed, the current economic conditions have thrown a curveball at the Fed.
“Persistent buoyancy in inflation numbers” probably “does give Fed officials pause that maybe the economy is running too hot right now for rate cuts,” said Kathy Bostjancic, Nationwide’s chief economist. “Right now, we’re not even seeing a ‘soft landing’ — we’re seeing a ‘no landing,” she added. This sentiment is echoed by a growing number of market analysts, who argue that the Fed may have lost some of its control over inflation and may struggle to keep it in check.
With the Fed’s dual mandate to promote price stability and maximum employment, the central bank is now facing a dilemma. On one hand, inflation has been ticking upwards, with the CPI well above the Fed’s target of 2%. On the other hand, the labor market has been showing mixed signals, creating uncertainty about the state of employment and economic growth. With one of the Fed’s primary tools for controlling inflation being interest rate adjustments, the decision to delay or remove rate cuts altogether raises questions about how the central bank will handle this delicate balancing act.
“Prices are not going to revert to where they were, so the best we can look for is a moderation in the rate at which prices are going up,” said Sarah House, managing director at Wells Fargo. “You see some stabilization in some key areas like the grocery store; but overall, you’re still going to see consumers bothered by the current price environment for some time.” With a growing consensus that inflation may continue to rise in the coming months, some experts warn that the Fed’s hands may be tied in terms of cutting interest rates. And for many Americans already struggling with rising costs of living, this could spell trouble.
Hedging Against Risks
The “long awaited last mile” of the Fed’s campaign to rein in inflation may feel more like a “last marathon” for many as they try to keep up with rising costs. With the possibility of no rate cuts this year amid reaccelerating inflation, consumers may find themselves facing higher prices without the relief of lower interest rates. And as the cost of borrowing money remains higher for longer, experts say many Americans could struggle to make ends meet, especially those on fixed incomes or with high levels of debt. This could have serious consequences for the economy as a whole, potentially slowing down consumer spending and economic growth.
To hedge against these risks, many financial experts recommend considering precious metals like gold to diversify savings portfolios. The value of gold, which is denominated in U.S. dollars, typically moves inversely to the value of the dollar itself. This means that a decrease in the dollar’s value can lead to an increase in gold prices, as investors find their purchasing power diminished, making gold more valuable per dollar spent. This dynamic can make gold an attractive option during times of economic uncertainty or inflation, as it can help to stabilize and potentially grow the value of one’s savings. For Americans who may be facing financial insecurity due to rising inflation, diversifying savings with gold could provide peace of mind at a time when nothing seems certain.
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