The Persistent Challenge of Inflation: Why It’s Still a Major Concern Despite Signs of Relief

While the Federal Reserve is making strides toward its inflation goal, the issue of rising prices is still a pressing concern for individuals, businesses, and policymakers across the United States.

Current reports on prices of goods and services indicate that inflation has decreased but remains slightly above the central bank’s target of 2%.

Goldman Sachs recently predicted that inflation could approach the 2% mark when the Bureau of Economic Analysis releases its favored price index later this month.

However, inflation is complex and cannot be captured entirely by a single statistic. Many indicators still show that inflation levels are higher than what most Americans—and even some Federal Reserve officials—are comfortable with.

During a recent address, San Francisco Fed President Mary Daley pointed to signs of easing inflation pressures but emphasized that the Fed must stay alert and proactive, refusing to declare victory too soon.

“Consistent progress toward our objectives cannot be assumed, so we need to be vigilant and strategic,” she said at New York University’s Stern School of Management.

Daley started her speech by sharing a recent encounter where a young man, pushing a stroller and walking his dog, asked, “President Daley, are you declaring victory?” She reassured him that she was not celebrating yet regarding inflation.

This exchange highlights a key challenge for the Fed: why are interest rates still high given that inflation appears to be easing? Those who remember the inflation struggles of the 1970s might recall the urgency behind the “Cut Inflation Now” movement. But why might the Fed consider lower interest rates?

In Daley’s view, the 0.5 percentage point rate cut in September represented a necessary adjustment to align the interest rate landscape with current inflation realities that have significantly shifted since mid-2022. This decision also reflects indications of a softening labor market.

Yet, as the young man’s question illustrates, it remains difficult for many to grasp that inflation is truly tapering off.

It’s essential to keep in mind two considerations about inflation. First, the eye-catching 12-month inflation outlook; second, the cumulative effects over a longer three-year time frame.

Simply focusing on yearly rates provides a narrow view of the situation.

The Consumer Price Index (CPI) inflation rate in September stood at 2.4% on an annualized basis, a significant drop from its peak of 9.1% in June 2022. Although CPI is often in the public spotlight, the Fed monitors the personal consumption expenditures (PCE) price index more closely. Goldman Sachs estimates that the PCE is just a few hundredths of a point shy of the 2% target.

Inflation surpassed the 2% mark for the first time in March 2021; initially, Fed officials regarded it as a fleeting result influenced by pandemic-related issues that would soon dissipate. During his policy address at the Jackson Hole summit in August, Fed Chair Jerome Powell humorously referred to the “good ship Transitory” and all its metaphorical passengers during the early inflation rise.

However, it’s become evident that inflation is not merely a temporary concern, with the overall CPI increasing by 18.8% since that time. Food prices surged by 22%, and key items like eggs have skyrocketed by 87%, car insurance rates have risen by about 47%, and while gasoline prices have recently dropped, they are still up 16% compared to then. Additionally, housing prices have surged, with median home prices climbing 16% since the first quarter of 2021 and 30% since the pandemic-driven demand spike.

While some broad inflation measures, like the CPI and PCE, are showing signs of retreat, others depict stubborn trends.

For instance, the Atlanta Fed’s “fixed price” inflation measure (which covers items like rent, insurance, and healthcare) decreased in September, whereas the “flexible CPI,” which encapsulates the more volatile food, energy, and auto prices, remained high at 4%. The fixed figure saw a notable decline of -2.1%. This means that while prices for steadily priced items remain elevated, those subject to fluctuation, such as gasoline, are starting to decline.

This fixed price index also brings another crucial aspect into focus. ‘Core’ inflation, which excludes the often-volatile food and energy prices, remained at 3.3% in September based on CPI and 2.7% in August according to the PCE index.

Though Fed officials are currently paying more attention to headline figures, historically, they have considered core inflation to be a more reliable indicator of long-term trends, adding to the complexity of the inflation situation.

Prior to the inflation surge in 2021, American consumers experienced minimal inflation. Despite ongoing frustrations with rising living costs, spending has persisted.

According to the U.S. Bureau of Economic Analysis, consumer spending reached nearly $20 trillion on an annualized basis in the second quarter. Retail sales in September increased better than anticipated by 0.4%, while the segment impacting GDP calculations rose by 0.7%. However, comparing year-over-year spending growth of 1.7% with the CPI inflation rate of 2.4% shows that spending is lagging behind inflation.

A growing portion of this spending is funded via various types of debt instruments.

As of the second quarter of this year, U.S. household debt hit $20.2 trillion, up by $3.25 trillion, or 19%, since the inflation started to climb in early 2021, according to data from the Federal Reserve. Household debt grew by 3.2% in the second quarter, marking the most significant increase since the third quarter of 2022.

Rising debt levels have not yet become a significant crisis, but the situation is growing more concerning.

The current delinquency rate has reached 2.74%, the highest in approximately 12 years, though it remains slightly below the long-term average of about 3% since the Federal Reserve began tracking this data in 1987. A recent survey by the New York Federal Reserve indicates that consumers are becoming more aware of potential increases in debt delinquency. The percentage of respondents who anticipate missing at least one minimum payment in the next three months surged to 14.2%, marking the highest rate since April 2020.

Moreover, the trend isn’t just limited to individual consumers accumulating debt.

As reported by Bank of America, credit card spending among small businesses has been on the rise, increasing over 20% compared to pre-pandemic figures and approaching levels not seen in a decade. Should the Federal Reserve implement rate cuts, economists at the bank believe that this could alleviate some financial pressure; however, the extent of potential cuts may be questioned if inflation remains stubbornly high.

Interestingly, while small businesses are increasing their credit use, these balances have not fully kept pace with the 23% inflation climb since 2019. This has been a bright spot in the scenario for them.

Yet overall, the sentiment among small and medium-sized businesses remains bleak. According to a September survey conducted by the National Federation of Independent Business, 23% of participants indicated that they perceive inflation as a significant challenge, making it the foremost concern among its members.

With both positive and negative developments regarding inflation, the Federal Reserve faces crucial decisions during its policy meeting scheduled for November 6-7.

Market participants have been on edge since the Fed opted for a 0.5 percentage point (50 basis point) rate cut in September. Instead of anticipating further rate reductions, markets are now beginning to show signs of increasing rates.

For instance, 30-year fixed mortgage rates have climbed roughly 40 basis points since that cut, as reported by Freddie Mac. Additionally, the five-year break-even rate, a measure that compares five-year government notes with Treasury inflation-protected securities, has also seen a similar uptick, rising by about a quarter of a point, reflecting the highest levels observed since early July.

SMBC Nikko Securities stands alone on Wall Street by recommending the Fed to pause further rate cuts until clearer economic signals emerge. They caution that as the Federal Reserve transitions to a more dovish stance, stock markets are achieving new highs, yet weakened financial conditions could lead to an uptick in inflation. Atlanta Fed President Rafael Bostic recently suggested the possibility of a shutdown in November.

Joseph LaVogna, chief economist at SMBC and former senior economist for President Donald Trump, explained, “For Fed policymakers, easing interest rates might further relax financial conditions, boosting the wealth effect via rising stock prices. Yet, the persistent concerns surrounding inflation remain.” Trump reaffirmed this viewpoint in a memo released Friday.

This backdrop leaves many individuals feeling apprehensive about what lies ahead, reminiscent of a young man who interacted with the San Francisco Fed president, expressing uncertainty about the direction of the Fed’s policies.

During a speech in New York, Daly reflected on these concerns, stating, “I envision a scenario where individuals have the opportunity to recuperate before moving forward. Hence, I shared my version of success with the young father on the sidewalk, and I will consider my job completed when this is achieved.”