It’s an unfortunate truth, but inflation is far from defeated. On Thursday, the Bureau of Labor Statistics reported consumer price inflation for October. The headline inflation number was 0.4%, with core inflation at 0.3%. The numbers were a little bit better than expected, but inflation remains very elevated. The Cleveland Federal Reserve sees headline inflation for November running up over 7% both monthly and annually. That is a far cry from the Federal Reserve’s 2% inflation target.
Equally important, the Cleveland Federal Reserve projects that the headline personal consumption expenditure price index will increase by over 6% for both October and November. Moreover, the core personal consumption expenditure price index, the Federal Reserve’s preferred measure, will be increasing at a rate of about 5% for both months.
The San Francisco Federal Reserve states the obvious: When inflation is high, workers demand higher wages. Even when inflation begins to fall, workers want more money to compensate for past inflation and as a hedge against future inflation. At the moment, there are few signs of a slowing economy. The employment market remains super tight. The services sector continues to grow. That is 70% of the economy or more. Employment in the services sector is strong. Wage growth is elevated. There are few signs of a slowdown in services. Consumers have $1.7 trillion in excess savings. They are spending especially on travel and leisure. The Atlanta Federal Reserve forecasts fourth-quarter GDP growth of over 3%. The inflation battle is far from over.
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Economic history teaches that embedded wage inflation is worse than a short sharp recession. When wage inflation is entrenched, workers, rightly or wrongly, believe that inflation is outpacing wages. Workers don’t like to be paid less. In addition, when inflation is well established, capital is allocated poorly. National prosperity suffers. Unfortunately, monetary policy affects the economy with a long lag, often a year or longer. So, the Federal Reserve is in a hard place. It must continue to raise rates, knowing that with each rate increase, recession risk rises. But as Federal Reserve Chairman Jerome Powell noted last week, it is better to tighten now than to pause and allow inflation to become even more rooted in the economy.
The country and markets must worry about inflation, about recession, and the burden of financing the federal debt, which is held by the public. Publicly held debt is almost equal to 100% of the GDP. Therefore, each 1% increase in borrowing costs for the U.S. Treasury raises federal government demands on national capital by 1% of the GDP. Since the Federal Reserve began to tighten monetary policy, the interest rate on the two-year Treasury lending note has increased from 1% to about 4.4%. Each time the Treasury rolls over two-year debt, the interest cost increases over four-fold. For the 10-year Treasury, the roll-over burden is also daunting. One year ago, the cost for the U.S. Treasury to borrow 10-year money was under 2%. Today, the cost is just under 4%.
Put simply, tough times lay ahead.
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James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
