With Hotter Than Expected Inflation Fed’s Rate Conundrum Deepens

With the hotter than expected inflation the Fed’s rate conundrum deepens. The Federal Reserve is in a tight spot as the inflation data for the past two months increased. The conundrum of the Fed rate cut deepens and awaiting the response/solution. 

In December, the Federal Reserve officials predicted that, in 2024, they might reduce the interest rate by 0.75% from its current range of 5.25% to 5.50%. However, after witnessing an increase in prices in January and February uncertainty over this prediction. The data indicates that the downward trajectory of inflation has stalled. 

This raises concern among some experts that the Federal Reserve may keep the interest rate higher for more time to fight inflation. The question of soft landing is still remains.

February Inflation Data

On 12^th March 2024, the U.S. Bureau of Labor Statistics released its Consumer Price Index (CPI) for February 2024. According to the press release, the CPI for All Urban Consumers (CPI-U) increased 0.4% (seasonally adjusted) in February after rising 0.3% in January 2024. The energy index increased by 2.3% over the month – due to an increase in all of its component indexes. The food Index remain unchanged in February.

The Core price index (i.e. all items minus food & energy) increased by 0.4% in February – as it did in January 2024.  Shelter, Airline Fares, Motor vehicle insurance, apparel, and recreation indexes all increased in February. The index for personal care and the index for household furnishings and operations decreased in February over the month. 

Source: U.S. Bureau of Labor Statistics

The All items index increased by 3.2% (before seasonal adjustment), over the last 12 months. This is a larger increase than the 3.1% increase in January (over the 12 months). The Core index increased by 3.8% over the last 12 months. The energy index declined by 1.9% over the last year. The Food index rose by 2.2% over the last year.

Source: U.S. Bureau of Labor Statistics

Inflation Expectations

On 11^th March 2024, the February 2024 Survey of Consumer Expectations, by the Federal Reserve Bank of New York’s Center for Microeconomic Data, was released. It reveals that while inflation expectations increased at the medium- and longer-term horizons, they remained constant at the short-term horizon. 

Estimates for household income and earnings growth were the same, while expectations for spending growth somewhat improved. In the event of a job loss, the average perceived likelihood of both voluntary and involuntary job separation increased, but the perceived likelihood of obtaining another employment decreased. Expectations and perceptions regarding credit availability became less optimistic. 

Tight Labor Market 

According to the U.S. Bureau of Labor Statistics, the Employment Situation – February 2024, the total Non-farm payroll employment increased by 275,000 and the unemployment rate increased by 3.9% in February. 

In February, the Job increased in health care, in government, in food services and drinking places, in social assistance, and transportation and warehousing.

For the third straight month, the labour force participation rate stood at 62.5% in February, while the employment-population ratio barely changed at 60.1%. There was hardly any change in these ratios over the years. 

It is also important to remember that the Job data for December and January. The change for December was revised down from +333,000 to +290,000, and the change for January was revised down from +353,000 to +229,000. Net employment over these months (i.e., for December and January) is 167,000 less than previously stated. 

Our Perspective

Inflation for January and February may have surprised the policymakers. Now, they have to recalibrate their stance on how to tackle inflation. The revision of the Job market data shows that the economy is slowing down. In other words, the earlier policy measures impact is slowly visible in the economy now. The good news is Inflation expectations for the short term remain unchanged. 

As we expected today (i.e. 20th March) the Federal Reserve kept interest rate unchanged. By keeping its interest rate unchanged, this is the fifth straight time and at a 23-year high of nearly 5.4%.

The FOMC will also release their Quarterly “dot plot” projections today (i.e. 20^th March 2024).  This will show how the FOMC officials view the economy and how they view the fed funds rate for the next few years. 

Now, the question lies in how long is too long and whether the economy may fall into recession. This entirely depends on the response of the policymaker’s to the reaction from the economy and the response of the economy going to give for the upcoming policies.

Conclusion

The Federal Reserve’s response to escalating inflation and evolving economic indicators will shape the trajectory of monetary policy and its impact on growth and stability. The delicate balance between combating inflation and supporting economic recovery underscores the complexity of the current economic landscape.

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