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The Fed’s Rough Ride as Inflation Picks Up Again.

By the end of 2023, US inflation had picked up steam, driven by unwavering expenses for services as a prolonged drop in goods prices fizzled out.

According to government estimates, the consumer price index climbed by 3.4% in the year ending in December, which is the highest increase in three months. Additionally, it increased more than anticipated on a monthly basis as housing costs were rising, driving expenses increased for Americans, and energy prices increased for the first time since September.

According to the data, the Federal Reserve will have a difficult time controlling inflation, which might remain high in the upcoming months if the cost of products like cars and clothes keeps rising. As a result of improved supply chains, Wall Street economists and Fed policymakers have begun to doubt the long-term viability of the recent downturn.

The majority of the surprise in so-called core goods—which do not include food and energy—came from increases in the cost of clothing and used automobiles, even in spite of year-end sales and promotions. Prices for services remained stable as well, most notably those related to housing and auto insurance, which saw the highest yearly increases since 1976.

“The concern that must be growing in the Fed’s mind at this point is that we are now getting less deflation and disinflation from goods and energy prices, and we still have yet to see a measurable reduction in inflation in housing or most services components,” Scott Anderson, chief US economist at BMO Capital Markets, said in a note. This implies that the Fed is still a long way from achieving sustainable inflation of 2.0%.

Nevertheless, the numbers cap a year in which inflation generally declined without significantly harming the labor market, paving the way for this year’s rate cut by the Fed. The most recent economic predictions from officials indicate that they anticipate three rate reductions in 2024, despite market expectations that the first reduction would occur as early as March.

Following the publication from the Bureau of Labor Statistics, the S&P 500 declined while Treasuries saw fluctuations. The Fed’s next meeting takes place at the end of this month.

In December 2023, there was a 0.5% increase in shelter prices, which account for around 33% of the CPI index overall and have contributed to almost half of its rise. A hike in hotel rates that had been lower the previous month was part of the gain. In order to lower core inflation to the Fed’s objective, economists believe that a persistent reduction in this area is essential.

According to estimations by Bloomberg, prices for services increased 0.4% from November, decreasing little from the previous month, when housing and energy were excluded. Although Fed Chair Jerome Powell and his associates have emphasized the significance of examining this indicator when evaluating the country’s inflation trend, they calculate it using a different index.

Car prices are not given the same weight in this metric as they are in the CPI, which is called the personal consumption expenditures price index. For this reason, when the core PCE gauge is revealed later this month, economists do not anticipate it growing as sharply. The trajectory for that group of indices has been substantially closer to the Fed’s 2% objective.

Additional hints will be revealed on Friday when the producer price index is released, since the PCE calculation is derived on multiple categories in that report.

The unexpectedly robust CPI report for December demonstrates that there are obstacles in the way of a steady return to 2% inflation, and the final stretch may be challenging. A portion of the disinflationary urge for core products, which has been a major factor in reducing price pressure in recent months, has subsided. Rent disinflation is probably not going to be enough to bring inflation down to the Fed’s target of 2%.

According to data released separately on January 8, 2024, the number of persons receiving unemployment benefits dropped to its lowest point since October, while the number of original applications for the program remained at a record low level last week.

The Fed is hoping for more relaxed labor market conditions to control demand throughout the economy, particularly in light of the jobs report that was largely positive last week. A different study released on Thursday revealed that real wages increased 0.8% in December compared to the same month last year, continuing a trend of wage growth that has somewhat outperformed inflation for several months.

US consumers became increasingly optimistic about the inflation forecast towards the end of the year, as seen by a number of near-term expectations indices falling to their lowest points since early 2021. This has improved consumer mood indicators.

For Joe Biden, it has not been the same blessing. Despite the success on alleviating price pressures, inflation has haunted Biden’s presidency, with his approval rating at comparable level today as it was when the aggregate CPI reached above 9% in June 2022.

The economy as a whole and this subject are highly valued by voters in this year’s election; yet, any further easing in the labor market could offset the electoral advantages of lower inflation.

Inflation is anticipated to continue to decline this year and approach the Fed’s 2% objective, particularly as housing costs are predicted to start to decline. A Middle East war escalation could push up oil prices, but other factors like low water levels in the Panama Canal and higher shipping costs as a result of attacks in the Red Sea could reverse the gains made in goods deflation.

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