Weekly Economic Update: September 16, 2024

Presented by Nicholas Wealth Management

Inflation rate continues to decline, but it’s a cautionary tale

The August Consumer Price Index (CPI) came in at 2.5% year-over-year last week. However, let’s put things into context before we declare victory over inflation and start popping champagne corks in celebration.

Inflation is approaching the Federal Reserve’s stated target of a 2% annual growth rate, which is the “acceptable” rate of increase for the Fed. Prices have risen by more than 20% since the pandemic, and they are still increasing by 2.5%, based on the CPI.

For most folks, wages haven’t kept up over the past four years, which means they’re buying less and spending more than they did in 2020. Many are also borrowing more to keep up and paying higher interest rates to access borrowed funds, as the average annual rate for credit card balances was 21.51% in the second quarter of 2024.

The markets want the Fed to lower rates (more in the next section), so they celebrated the lower inflation number last week. But it wasn’t low enough to warrant a rate cut of 25 basis points (.25%) because all that inflation has embedded itself in producer inputs, rents, the price of housing and labor costs. This makes lowering product costs harder because materials still cost more. And no one wants to sell their house for less or borrow the money to pay for the higher price of housing, plus we’re paying people more in wages. That 20% increase is pretty much here to stay.

Some of the CPI improvement has come from declining energy prices, which fell 0.8% in August and are down 4.0% over the last 12 months. Energy prices are highly volatile and could spike upward just as quickly, given our dependency and vulnerability to external sources and global events. “Core” inflation (excluding energy) is up 3.2% in the last year, while “super core” (excluding food, energy and housing rentals) is up 4.5%. We are told that the Fed pays more attention to core CPI than regular. So, does the Fed start cutting rates when inflation is effectively at 4.5% and has been running above the Fed’s 2% goal for 42 straight months? Is this the new metric of normal?

Finally on inflation, the Producer Price Index (PPI) — which is the cost of the stuff needed to make the stuff — is up 1.7% over a year ago. Energy prices have played a major role in lowering PPI as well, but if you remove energy fluctuations, things aren’t as rosy as you might think. Just as with CPI, energy continues to be a key driver in the decline of producer input costs. But again, a quick glance at a 5-year chart for the price of oil reminds us that energy costs can reverse quickly and to our detriment.

For now, all the market sees is a rate cut and the potential for more cuts. We are getting to a fork in the road, where Wall Street may be rejoicing while Main Street struggles. That’s the cautionary tale here.

The Fed’s balancing act

Markets are virtually 100% sure the Fed will cut at least one-quarter of a percentage point (25 basis points or 0.25%) at the conclusion of its meeting on Wednesday. The expectation is for the fed funds rate to move from 5.25% to 5%.

Will this make a difference in our everyday lives? Absolutely not — but what it does signal is that the “higher for longer” narrative is done, and we have entered a rate-cutting cycle. How that plays out is anyone’s guess, but at least we will have an actual rate cut and are no longer bouncing from one Fed meeting to the next with the same old “hope and wait for next time” routine.

Is this the right move right now? It may be the only move, in our opinion. All of this could have been avoided if the Fed had cut by 25 basis points in July and left the door open for a bigger cut in September while giving itself the opportunity to take a “wait-and-see” attitude the rest of the year.

We don’t typically give credit to European financial policy experts, but this time around, it appears they actually took an enlightened approach. Last week, the European Central Bank (ECB) cut interest rates for the second time in three months, moving from 4% to 3.5%. This is what taking the initiative looks like. They can always pause again down the road if inflation flares up, but the ECB is being proactive — unlike our Fed. Another thing to note is that at 3.5%, it’s cheaper to do business in the EU than it is at 5% in the U.S., which gives Europe an advantage over us.

All eyes will now be on the next two Fed meetings in November and December and whether the data continues to deteriorate to the point where the Fed will need to make bigger cuts. That’s not taking the initiative and is highly reactionary! The danger here is that the data’s deterioration will outpace the Fed’s ability to react. Will the Fed not only throttle the markets but run the entire economy into a recession by cutting rates by too much and too late? It’s a tough balancing act, and my fear is the Fed will slip.

Coming This Week

• This week will be all about the Fed meeting on Tuesday and Wednesday, with a rate announcement on Wednesday afternoon.
• On Wednesday, we’ll have MBA mortgage applications and housing starts. Thursday will feature weekly unemployment claims, the Philly Fed manufacturing survey, existing home sales and leading indicators. No data is scheduled for reporting on Friday.
  

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