04.13.2023 0

Inflation dips to 5 percent as demand begins collapsing, Fed set to keep increasing

By Robert Romano

The consumer price index has continued to descend from its June 2022 peak of 9.1 percent down to a still elevated 5 percent in March 2023, according to the latest reading from the Bureau of Labor Statistics.

The decrease was almost exclusively due energy prices continuing to stabilize, with oil prices being down in March, with gasoline down 4.6 percent and fuel oil down 4 percent in just a month.

Electricity was down 0.7 percent and piped gas service was down another 7.1 percent in March, following an 8 percent drop in February.

But that was before OPEC+ slashed production in early April, which has seen light sweet crude oil rise from about $67 a barrel in late March to now about $83 a barrel in April, a 24 percent increase that will surely find its way to gas prices over the next several weeks.

The production cut was predicated on anticipated weaker demand, and so over the longer term prices could wind up dropping anyway.

However, the sudden rise in oil prices could serve notice on the Federal Reserve that inflation pressures due to supply issues are still very much an issue, as much as the $6 trillion that was printed, borrowed and spent for Covid is, which came at a time of production halts, economic lockdowns and paying people to stay home.

The M2 money supply increased dramatically from $15.3 trillion in Feb. 2020 to a peak of $22 trillion by April 2022, a massive 43.7 percent, leading to the inflation spike, where consumer inflation reached 9.1 percent in June 2022. By the time Russia invaded Ukraine in Feb. 2022—further worsening global supply issues—consumer inflation was already north of 7.5 percent. The M2 money supply has now decreased a bit to $21.1 trillion.

On March 22, the Federal Reserve noted that continued increases of the Federal Funds Rate, or “additional policy firming,” could be on the horizon, stating, “the Committee decided to raise the target range for the federal funds rate to 4-3/4 to 5 percent. The Committee will closely monitor incoming information and assess the implications for monetary policy. The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

The central bank added, “In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

In just a year, the Fed has gone from 0.08 percent in Feb. 2022 on the effective Federal Funds Rate — at which point inflation was already 7.5 percent — to now 4.65 percent in March, leading to much hand-wringing on Wall Street about interest rates rising faster than ever.

To be certain, it is one of the quicker paces of increases of the Federal Funds Rate in recent memory, looking a bit further back in history, it looks a lot like the rate increases that combated the inflation of the 1970s and 1980s.

For example, in 1981, when the effective Federal Funds Rate rose from 14.7 percent in March 1981 to 19.1 percent in June 1981, a 4.4 percent increase.

That was dwarfed by 1980, when rose from about 9 percent in July 1980 to 19.1 percent in Jan. 1981, a 10.1 percent increase.

Or in 1979, when it rose from about 10.1 percent in April 1979 to about 17.6 percent in April 1980, a 7.5 percent increase.

Or 1973, hen it rose from Sept. 1972 to Sept. 1973, from about 4.9 percent to 10.8 percent, a 5.9 percent increase.

Those were rocky times, too, but what the Fed is doing is by no means unprecedented. What was unprecedented was printing $6 trillion and simultaneously shutting the economy down and reducing production—too much money chasing too few goods.

The Fed’s rate hikes come as 10-year treasuries remain at about 3.37 percent of this writing, and 30-year mortgage interest rates are at about 6.3 percent as existing home sales remain down about 22.6 percent from their 2022 highs a year ago, according to the National Association of Realtors.

The news comes as the annual growth of consumer credit appears to have peaked at 8.1 percent in Oct. 2022, flattening slightly to 7.8 percent annualized by Dec. 2022 and then ticked up to 7.9 percent Jan. 2023 and now is down to 7.6 percent in Feb. 2023, which could be a sign of weakening demand. Usually, it peaks just before or at the beginning recessions, and then will slow down significantly once unemployment begins rising.

Either way, a slowdown in the growth of consumer credit could indicate American households are maxing out on their credit cards, which will have a dampening effect on demand going forward.

And yet, unemployment remains at historic lows of 3.5 percent, and with the Fed projecting a 4.6 percent unemployment rate in 2024, as many as 2 million job losses still appear to remain on the horizon, meaning there’s still room for the Fed move rates higher. To be certain at 5 percent inflation, it would only take another quarter point hike or so to get the Fed’s interest rate above that of the consumer inflation rate. Stay tuned.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government Foundation.

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