Inflation Cools, Leaves America: What Comes Next?

Martin Pate, a 31-year-old transportation planner in Fort Worth, felt “treading water” by mid-2022 with higher gas prices, rising food costs and the prospect of big rent increases.

“Since graduating college, I’ve started to feel really squeezed financially in a way I’ve never felt before,” Mr. Pate said. Since then, he has been promoted and given a 12 percent raise. Gas prices have dropped, and local housing costs have dropped enough that next month he’s moving into a nicer apartment for less per square foot than his current place.

“My personal situation has improved a good deal,” said Mr. Pate said, explaining that he is cautious but optimistic about the economy. “It looks like it might just develop.”

People across the country are enjoying some relief from the relentless rise in the cost of living. After repeated false dawns in 2021 and early 2022 – when price increases begin to accelerate again – signs are beginning to pile up that inflation is indeed turning a corner.

Inflation has come down On an annualized basis for six consecutive months, it has fallen to 6.5 percent from about 9 percent last summer, partly because gas has become cheaper. But the decline is true even after stripping out volatile food and fuel: So-called core consumer prices have risen 0.3 percent or less in each of the past three months. That’s faster than the 0.2 percent monthly changes that were typical before the pandemic, but much slower than the 0.9 percent peak in April 2021.

America may have finally reached an inflection point in inflation. The question now is what is going to happen next.

Some economists expect inflation to remain stubbornly faster than before the pandemic, while others expect a steeper decline. Some expect something in between. Which expectation matters most: The pace and scope of inflation cooling will inform how much Federal Reserve policymakers raise rates, how long they raise them and how much pain they inflict on the economy.

For now, the dizzying uncertainty has prompted Fed officials to come out in favor of further slowing — but not stopping — their interest rate hikes from Jan. 31-Feb. 1 meeting. Officials pulled back from their previous three-quarter-point increase to a half-point move in December, and many favor raising rates by a quarter-point this time. And moving more gradually will give policymakers more opportunity to see how the economy is developing, and reduce the risk that they will drive the economy off a cliff.

“If you’re on a road trip and you encounter foggy weather or a dangerous highway, it’s a good idea to slow down,” Dallas Federal Reserve Bank President Lori Logan said during a speech last week. The same considerations prompted central bankers in December to “recommend further tapering at the upcoming meeting.”

Officials have entered their quiet period before the meeting, so in the past week Ms. The comments made by Logan and his colleagues are the last that investors will hear until then. Central bankers welcomed the recent slowdown in inflation – but said it was premature to declare victory, and stressed the broader uncertainty ahead.

Many economists and central bank officials estimate that it will take years for inflation to return to its usual 2 percent annual rate. But some on Wall Street think inflation could fall sharply, perhaps returning to the historically low levels that prevailed before the pandemic. The stark divide is visible: The highest forecast in a Bloomberg survey of economists expects consumer price inflation to be at 5 percent or more by the end of 2023, while at the same time slowing to at least 1.5 percent.

The central bank will receive more information on inflation this week. The Personal Consumption Expenditure Index is expected to have risen by 5 percent in December from a year earlier at 5.5 percent in November. That measure is related to consumer price index inflation action but is too late, and is the central bank’s official target.

As officials and economists try to figure out what will happen with inflation, the fate of everyday Americans hangs in the balance. If the central bank slows the economy too much in its efforts to control prices and causes a steeper recession than necessary, people will pay for their work.

But if continued rapid price increases do not chip away at wage gains and erode savings, it will leave families worse off.

“I worry about the future. And groceries have skyrocketed in the last couple of years.

Ms. For people like Loeb, central bankers have good reasons to believe that inflation will slow significantly in 2023.

Housing costs are still rising in official price data, but real-time rent trackers show a steep slowdown in asking rents. Economists expect that to feed inflation data in the coming months.

As for cars, used — and, more recently, new — inventory is improving, which is already leading to a decline in automobile prices. And prices of a wide range of other commodities are reducing their rise or fall as shipping costs return to prepandemic levels and supply shortages ease.

Rapid commodity inflation has been touched by supply issues, partly a function of strong demand: Consumer spending on households and other goods has risen since 2020 as households took government stimulus payments and cash they saved during the pandemic. lockdowns and spent it on renovations or camping gear. But the need is there decreases Savings are slowly being eroded.

Also, the Federal Reserve raised interest rates from zero Above 4.25 percent Last year, that could weigh on consumer spending and make it harder for companies to institute big price hikes without scaring away shoppers.

“It looks like a prolonged supply shock — to some extent a demand shock — that we’re enduring,” said Omair Sharif, founder of Inflation Insights. “These things seem very clearly on the path to normalization.”

In encouraging terms, prices for more than a few goods or services indicate a recession. The share of product categories with inflation above 3 percent fell from nearly three-quarters at the start of 2022 to less than a half in December, Christopher Waller, the Fed’s governor, said. said in a speech Last week.

But it’s unclear whether the forces pulling inflation down will be enough to quickly return prices to the central bank’s target annual pace of 2 percent.

Short-term volatility is possible. Mr. Sharif said the cost of medical care services coupled with higher Medicare reimbursements could help monthly inflation pick up again briefly in the coming months, for example.

And cost increases may have the potential to stay longer. Central bank officials forecast that inflation, as measured by the personal consumption expenditure index, will be 3.5 percent by the end of the year, removing volatile food and fuel prices. It will be well above 2 percent till 2024.

That expected resilience is linked to a rebounding labor market. With wages rising at an unusually rapid pace as firms try to attract and retain workers, central bank policymakers think firms may continue to raise their prices to cover costs. Higher incomes, meanwhile, allow shoppers to buy the things they want and need.

That’s why many central bankers expect to raise interest rates slightly higher and keep them at high levels through 2023. Higher borrowing costs will discourage consumers from borrowing and businesses from spending, further cooling demand in the economy and job market.

Wage growth is already showing some signs of slowing, and the Fed will get another Employment Expense Schedule Report Its Feb. 1 the day before the rate decision.

While other labor indicators were more resilient, central bank officials in their latest economic forecast predicted unemployment would rise to 4.6 percent by the end of the year, up from 3.5 percent now.

While that will hurt some households, central bank officials still hope for a relatively soft landing. In light of recent inflation data, Harvard economist and former Treasury Secretary Lawrence H. Summers, too, has warned that the economy could be headed for a sharp downturn, improving America’s chances of avoiding a painful recession.

“Soft landings are triumphs of faith over experience, but sometimes faith triumphs over experience,” said Mr. Summers said in an interview with Bloomberg Television last week.

Still, many investors think the U.S. economy will slow so much in the coming months that it could sink into an outright recession, pushing the Fed to cut rates by the end of the year.

Nobody really knows. Unexpected events — new developments in Ukraine, the development of a painful debt ceiling conflict, or a new and unexpected pop in oil prices — could raise the growth and inflation outlook.

“The last few years have been flying completely blind” for forecasters, Mr. Sharif said. “It’s slowly normalizing, but it’s still hard.”