Fed Holds Rates Steady For Now
The Federal Reserve Open Market Committee (FOMC) met last week for their final meeting of 2023. They held rates steady, but also released updated projections expecting three 25 basis point rate cuts in 2024. US Equity markets rallied on this news and rates declined. The main discussion now centers not on if, but when cuts may begin, with some expecting March 2024.
Powell Cautions Overconfidence
At the post-meeting press conference, Chairman Powell cautioned that it’s too soon to declare victory over inflation, despite stronger than expected 2023 economic growth. The FOMC lowered 2024 projections, stopping short of predicting recession. They forecast 2.4% Core PCE inflation by end 2024, down from 2.6% in September.
Inflation Still Elevated in Key Areas
It is easy to see why the Fed would be wary of overconfidence in their expectations for inflation. In order for Core PCE to be at 2.4% by the end of next year, it will need to average 0.2% each month. While last month core PCE was 0.2%, the general trend was above 0.2% with a few surprise upward moves. We would also need to see sustained declines in stubborn inflation hotspots in the service sector. There are still many areas where inflation could prove sticky and Fed’s expectations will be disappointed.
CPI Inflation
At the tail-end of last week, we also received a reading on CPI inflation and noted the monthly rate increasing slightly, while the year-over-year rate for headline CPI declined slightly.
However, most of the decline was due to a lowering in energy prices. When we look at the Core CPI (CPI less energy and food), we see a stronger uptick in the monthly rate and the yearly rate is essentially flat at 4%.
When we look at the subsectors for CPI, we see that services and housing is running well above the 2-2.5% target of the Fed, and that declines this year have been heavily borne by non-durables and durables.
As spending shifted from goods to services, we have seen weakness in goods and manufacturing with ongoing strength and inflation in services and housing.
It is hard to imagine the economy maintaining this “split personality” of behavior for the longer term and us still achieving the Fed’s inflation goals. Can we really have an ongoing recession in goods and manufacturing, while the service side of the economy runs inflation at almost twice the Fed’s goals?
While recession and soft landing are two terms that have dominated the press and discussion of our economic growth, there is a third situation that we have discussed: stagflation. While stagflation could be considered part of a soft landing scenario (because in both situations we avoid a recession), it seems that our current situation is headed more toward stagflation than a soft landing. When we consider real (inflation-adjusted) hourly earnings, the monthly rate has more recently moved between positive and negative territory with the annual rate slowly rising from negative to positive.
Wage Growth Only Now Outpacing Inflation
So, while the economy has shown solid growth throughout the year, the average worker has only now begun to outpace inflation with earnings. In a year we may say that a soft landing was more of a pyrrhic victory over inflation—where inflation came down but real household wealth was stagnate.
Retail Sales Pick Up, But Still Weak Adjusted for Inflation
We also got a reading on retail sales and both the monthly and annual rate picked up, but inflation-adjusted numbers remain slightly negative.
Outlook Still Uncertain
We could still see recession in 2024. But with possible real earnings gains, soft landing remains possible, albeit stagnant for many. Current trends signal “stagflation lite” may be the best descriptor.
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