Inflation Update
The Fed released its "Dot-Plot" last Wednesday. Succinctly, here's what means to folks like us...
· Groceries[i]
o The Problem: Nationally, seven in 10 consumers say they are very or extremely concerned about the cost of groceries, more than any other spending category, including gasoline and rent or housing, according to a February poll by the grocery-industry trade group FMI. Forty-two percent said they were worried about having enough money to buy food in December, the last time FMI asked, compared to 26% at the March 2020 onset of the pandemic.
§ Households with income <$50,000/year are being hit the hardest.
§ Groceries tops the list of consumer inflation concerns (69%) followed closely by Gasoline (61%) then Rent/Housing (59%). [ii]
o The Blame: The White House is amping up criticism of food companies that Biden officials say won’t bring down prices despite healthier profit margins than pre-pandemic times.
§ Grocery companies counter that they’re offering cheaper products to consumers looking to save money and working with suppliers to keep prices low. Economists are divided on the role corporate price-gouging may play in US inflation.
§ “Markups for all retailers spiked during the pandemic, but as they’ve come back down for all other retail groups, food and beverage markups remain elevated,” Jared Bernstein, chairman of Biden’s Council of Economic Advisers, said in an interview. “As their supply chains have improved and some of their input costs have eased, these producers appear to be lagging in passing savings to the customers.”
§ The Federal Trade Commission sued in February to block Kroger Co.’s $24.6 billion acquisition of Albertsons Cos., arguing the merger would drive up grocery prices.
§ Democratic Senator Bob Casey, facing a competitive reelection fight in Pennsylvania, has hammered away at grocery prices for months. In February, he introduced legislation — endorsed by Biden — to crack down on “shrinkflation” by targeting it as an illegal unfair and deceptive trade practice.
§ Casey said his constituents “are sick and tired of digging deeper into their wallets for their weekly grocery runs while corporate executives laugh all the way to the bank.”
o The Causal Factors: The food sector’s Post-Pandemic concentrated supply chains, global turmoil and extreme weather are responsible for the run-up in prices, said Gary Barraco, an assistant vice president at the supply chain software company e2open. Russia’s invasion of Ukraine also drove up the cost of crucial farm supplies including fuel and fertilizer, he added.
o The Solutions: Food prices aren’t likely to go down before the November election, said Arun Sundaram, an analyst for CFRA Research.
§ Still, the US Agriculture Department forecasts grocery inflation will be contained to 1.6% for this year, citing slowing energy costs and falling prices for some agricultural commodities and farm supplies such as fertilizer.
§ How much food inflation eases will be partially driven by a struggle between grocery chains and their suppliers over costs. In France, grocer Carrefour SA pulled PepsiCo Inc. products from shelves in January because of price hikes.
§ Food producers and retailers are grappling with how to get shoppers to load up their grocery carts, including appealing to them through discount promotions, said Moritz Breuninger, a principal specializing in food and beverage companies at Kearney, a management consulting firm.
§ “You don’t want to give back what you’ve built” by dropping prices too much, Breuninger said. But food companies risk antagonizing retailers with more price increases. “They know it’s going to be a tough conversation.”
o Where Inflation is Highest: January’s data shows…[iii]
§ Southern and Pacific states, including (Alabama, Kentucky, Mississippi, Tennessee, Georgia & Florida) saw 3.6% annual rates of inflation;
§ East-North Central region (Michigan, Wisconsin and the northern tier of states into New England) saw 2.5% annual rates of inflation;
§ Rocky Mountain states and the Great Plains saw roughly 3% annualized rates of inflation.
· A Tale of Two Economies[iv]
o The Federal Reserve faces a conundrum when it comes to rate policy. On the one hand, inflation remains stubbornly above 3% as measured by the consumer price index, financial conditions are arguably easy as measured by gauges of the equity and bond markets, and the top quintiles of US households that account for the majority of spending are flush with cash. On the other, consumer and small business delinquencies are high and rising. And the latest household survey for the employment report showed job losses. It’s a world of haves and have nots.
o Interest income is a lens for understanding the dichotomies
§ Let’s think about how interest-rate policy works to get a sense of why the Fed’s job is so hard. If monetary policy is to slow the economy, it has to be restrictive by raising interest rates across the economy. That, in turn, means borrowing costs have to become onerous enough to meaningfully slow the pace of consumption and investment.
§ None of that happens without distress.
§ In a perfect world, consumers and businesses simply restrict their new purchases, the economy slows, and all is well. But in the real world, higher rates and tighter monetary policy mean financial hardship and bankruptcy. And this happens from the bottom up. Those in the most precarious financial situations are the ones who lose out first and most.
§ You can see that if you look at interest income. For households with fixed- rate mortgages and little or no student and auto debt, higher rates just mean more interest income. All of their liabilities are fixed but their assets are earning more. Higher rates basically mean they are better off. This is true for most households in the upper two quintiles. And since they account for 61% of consumer spending, that fact can keep the economy going even as rates rise.
§ On the other hand, according to the latest numbers from the Bureau of Economic Analysis, “the annual interest bill that Americans pay on mortgages, credit cards and other debt has climbed by almost $420 billion since the Fed started tightening policy in March 2022. The rise in interest income over the same period was only about $280 billion.”[v]
§ Essentially, consumers in aggregate are paying more interest now than they were since the Fed started hiking rates — to the tune of $140 billion on a net basis. Since we know that the wealthier households own interest-earning assets and lower-income households face the most expensive kind of debt, what we’re seeing with the rate increases is a sort of reverse Robin Hood effect — where the Fed is rewarding creditors at the expense of debtors, hurting lower-income households more, even as the economy chugs along.[vi]
o All This Points to Fed Chairman Powell’s Dovish Speech Wednesday
§ The Fed is angling to cut as quickly as the data will allow. On March 29, we get the next read of the Fed’s preferred inflation metric. For the January data, PCE inflation came in at 2.4% overall and 2.8% excluding volatile food and energy items. The February read we get on the 29th is expected to show 2.8% for core PCE inflation but a mild uptick to 2.5% overall.
§ Having a number below 3% is a necessary but not sufficient pre-condition for cutting. But the big hurdle is gaining confidence that inflation is still falling toward 2%. If we see that 2.8% figure decline in the next few months to 2.4% or 2.5%, then we’re close enough to 2% with a falling rate of inflation that I think we’d get cuts. That means July is the earliest reasonable date to expect cuts, though we can’t rule out June.
§ The Atlanta Fed’s GDPNow tracker has been falling toward 2%,[vii] suggesting a bit of slowing, enough to boost the prospect of a soft landing instead of no landing as inflation heads down. Growth of 2% is pretty much bang-on the Fed’s estimate of the US economy’s long-term potential growth level. With inflation at 2.5%, that would be enough to get the first pre-emptive cut to relieve pressure on small businesses and lower income households.
o The Fed’s Rate Decision & Chairman Powell’s Briefing, Key Points[viii]
§ The Fed kept interest rates unchanged at 5.25% to 5.5%, as expected. The big news came from something else that went unchanged: the median projection for rate cuts this year. Policymakers still see three cuts this year.
§ Officials want to see more evidence that inflation is coming down toward the central bank’s 2% target before starting to cut rates.
§ January and February price data came in hotter than expected, but officials had thought the disinflation path would be “bumpy.” Powell said they didn’t overreact to last year’s quick price cooling and they also won’t ignore these higher prints.
§ Powell said that process of slowing the pace of the Fed’s balance sheet runoff will start “fairly soon.” He said slowing the pace doesn’t mean the process will end sooner, it will just ensure a smoother transition for markets as the Fed tries to avoid some of the stresses that emerged the last time it was conducting QT (circa 2018-2019).
§ As a result of all this, traders grew increasingly confident that the Fed will start lowering rates in June. The dollar fell as did yields and so, stocks and Treasuries rallied.
· BOTTOM LINE FOR INVESTORS: The S&P 500 had another record intra-day high and close.
[i] Soaring Food Prices Undermine Biden's Economic Pitch to Voters - Bloomberg
[ii] Survey by FMI: Food Marketplace Inc - Company Profile and News - Bloomberg Markets
[iii] Inflation January 2024: CPI Eases in US South, Remains Higher Than Average - Bloomberg
[iv] Cracks Are Now Appearing in the US Economy. What Does the Fed Do? - Bloomberg
[v] Fed Crushes Household Net Interest Income in Break From Past - Bloomberg
[vi] Cracks Are Now Appearing in the US Economy. What Does the Fed Do? - Bloomberg
[vii] GDPNow - Federal Reserve Bank of Atlanta (atlantafed.org)
[viii] Fed Rate Decision March 2024: 5 Takeaways From Meeting, Powell Speech - Bloomberg