Tag: Economy

Inflation is expected to have declined in December, but it may not be enough to stop the Fed

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A woman shops in a supermarket as rising inflation affects consumer prices in Los Angeles, California, June 13, 2022.

Lucy Nicholson | Reuters

The pace of consumer inflation is expected to have fallen slightly in December from the prior month because of a sharp drop in gasoline and energy prices, but the annual rate is still likely to remain uncomfortably high.

According to Dow Jones, economists now expect a decline of 0.1% in the consumer price index on a monthly basis, but inflation is still expected to climb at a 6.5% rate from the prior year. That compares to a gain of 0.1% in November, and a 7.1% pace year over year. However, the CPI is well off the 9.1% peak rate in June.

Core CPI, excluding energy and food, is expected to be up 0.3% in December, gaining 5.7% on a year-over-year basis. Core CPI rose 0.2% in November and 6% on a yearly basis.

“We welcome it with open arms. It’s good news,” said KPMG chief economist Diane Swonk of the expected decline. “It’s great and it helped to fuel consumer spending in the fourth quarter. … But it’s still not enough.”

The consumer price index is expected Thursday at 8:30 a.m. ET. It is the final CPI report before the Federal Reserve’s Feb. 1 interest rate decision. For that reason, the inflation number has become a major event for financial markets, and now some traders are betting it will show inflation slowing even more than economists forecast. They also point to weaker-than-expected wage growth in December’s jobs report, as well as other data that reflects lower inflation expectations.

Stocks rallied on Wednesday ahead of the report. “The market is looking at it as glass half full. Inflation is rolling over, and the Fed is almost done raising interest rates,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “I think they remember the last two months when you had numbers that were well below expectations. They’re just assuming that’s going to be the case again.”

Expected impact on the Fed

In the futures market, traders continued to bet the central bank will raise rates by just a quarter point at its next meeting. Meanwhile, some economists continue to expect policymakers will increase the fed funds target rate by a half percentage point. Market expectations are just 20% for a 50 basis point hike. A basis point equals 0.01 of a percentage point.

“It’s amazing how much reaction and overreaction there is for one single data point,” said Simona Mocuta, chief economist at State Street Global Advisors. “Clearly the CPI is very important. In this particular case, it does have fairly direct policy implications, which are about the size of the next Fed rate hike.”

Mocuta said a cooler CPI should influence the Fed. “The market has not priced the full 50. I think the market is right in this case,” she said. “The Fed can still contradict the market, but what the market is pricing is the right decision.”

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Wilmington Trust chief economist Luke Tilley said a 12% decline in gasoline prices in December and other decreases in energy prices — for expenses like home heating — helped drive inflation lower.

“Shelter is the main focus because of the lag,” he said. Rental market data shows a slowing in rates, but the CPI has not yet reflected it. “Everyone is familiar with the lag that it takes for the data to show up in the CPI,” Tilley added. “We think there could be a sharper slowdown.” Shelter costs are 40% of core CPI.

Shelter is expected to be up 0.6% month over month. Tilley said with the decline in the real estate market, he is hearing from landlords that they are having a more difficult time raising rents. “We’re penciling in slower increases in January and February and March on that shorter lag,” he said.

A focus on inflation in services

Economists are watching closely to see how much inflation related to services rises in CPI, since goods inflation is expected to continue to come down now that supply chains are operating more normally.

“The headline monthly changes over the last two, three months overstate the improvement. We’re not going to get the same help from gasoline in the next report. I don’t want to see an acceleration in shelter. I want to see some of the discretionary areas show deceleration,” said State Street’s Mocuta. “I think right now the focus is very much on the services side.”

The market is laser focused on inflation since the Fed’s progress in fighting it could determine how far the central bank will go on its rate hiking path. The rate increases are slowing the economy, and how much more it chooses to do so could be the difference between a soft landing or a recession.

“The hope is that basically we are now in a position where you could envision a soft landing. That requires the Fed to not only stop raising rates but ease up sooner and that doesn’t seem to be where they’re at,” said Swonk. “The Fed is hedging a different bet than the markets are. … This is where nuance is really hard. You’re in this position where you’re improving. It’s like a patient is getting better, but they’re not out of the hospital yet.”

The fed funds rate range is currently at 4.25% to 4.5%, and the central bank has forecast a final high rate of 5.1% for this year.

“The Fed is also worried about a second round of supply shock, whether it’s China’s abrupt abandonment of its zero-Covid policy or something else from Russia. They don’t want to declare victory too soon,” said Swonk. “They’re making that very clear. They’ve said it over and over again and nobody listens.”

Economists expect another key metric — the personal consumption expenditure deflator — could show core inflation slowing even below the Fed’s forecast of 3.5% by Dec. 31. Some economists who expect a recession predict rate cuts before year-end, as the markets expect. But the Fed has no forecast for rate cuts until 2024.

Some strategists expect Fed officials to begin to sound more dovish and less at odds with the market view. Boston Fed President Susan Collins said in an interview with The New York Times on Wednesday that she was leaning toward a quarter-point hike at the next meeting.

“We think one of the changes in coming months is the Fed will soon realize it is cheaper to change the inflation narrative than reverse a recession leading to millions of lost jobs,” writes Fundstrat founder Tom Lee in a note Wednesday.

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Why everyone thinks a recession is coming in 2023

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People who lost their jobs wait in line to file for unemployment following an outbreak of the coronavirus disease (COVID-19), at an Arkansas Workforce Center in Fort Smith, Arkansas, U.S. April 6, 2020.

Nick Oxford | File Photo | REUTERS

Recessions often take everyone by surprise. There’s a very good chance the next one will not.

Economists have been forecasting a recession for months now, and most see it starting early next year. Whether it’s deep or shallow, long or short, is up for debate, but the idea that the economy is going into a period of contraction is pretty much the consensus view among economists. 

“Historically, when you have high inflation, and the Fed is jacking up interest rates to quell inflation, that results in a downturn or recession,” said Mark Zandi, chief economist at Moody’s Analytics. “That invariably happens — the classic overheating scenario that leads to a recession. We’ve seen this story before. When inflation picks up and the Fed responds by pushing up interest rates, the economy ultimately caves under the weight of higher interest rates.”

Zandi is in the minority of economists who believe the Federal Reserve can avoid a recession by raising rates just long enough to avoid squashing growth. But he said expectations are high that the economy will swoon.

“Usually recessions sneak up on us. CEOs never talk about recessions,” said Zandi. “Now it seems CEOs are falling over themselves to say we’re falling into a recession. … Every person on TV says recession. Every economist says recession. I’ve never seen anything like it.”

Fed causing it this time

Ironically, the Fed is slowing the economy, after it came to the rescue in the last two economic downturns. The central bank helped stimulate lending by taking interest rates to zero, and boosted market liquidity by adding trillions of dollars in assets to its balance sheet. It is now unwinding that balance sheet, and has rapidly raised interest rates from zero in March — to a range of 4.25% to 4.5% this month.

But in those last two recessions, policymakers did not need to worry about high inflation biting into consumer or corporate spending power, and creeping across the economy through the supply chain and rising wages.

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The Fed now has a serious battle with inflation. It forecasts additional rate hikes, up to about 5.1% by early next year, and economists expect it may maintain those high rates to control inflation.

Those higher rates are already taking a toll on the housing market, with home sales down 35.4% from last year in November, the 10th month in a row of decline. The 30-year mortgage rate is close to 7%. And consumer inflation was still running at a hot 7.1% annual rate in November.

“You have to blow the dust off your economics textbook. This is going to be be a classic recession,” said Tom Simons, money market economist at Jefferies. “The transmission mechanism we’re going to see it work through first in the beginning of next year, we’ll start to see some significant margin compression in corporate profits. Once that starts to take hold, they’re going to take steps to cut their expenses. The first place we’re going to see it is in reducing headcount. We’ll see that by the middle of next year, and that’s when we’ll see economic growth slowdown significantly and inflation will come down as well.”

How bad will it be?

A recession is considered to be a prolonged economic downturn that broadly affects the economy and typically lasts two quarters or more. The National Bureau of Economic Research, the arbiter of recessions, considers how deep the slowdown is, how wide spread it is and how long it lasts.

However, if any factor is severe enough, the NBER could declare a recession. For instance, the pandemic downturn in 2020 was so sudden and sharp with wide-reaching impact that it was determined to be a recession even though it was very short.

“I’m hoping for a short, shallow one, but hope springs eternal,” said Diane Swonk, chief economist at KPMG. “The good news is we should be able to recover from it quickly. We do have good balance sheets, and you could get a response to lower rates once the Fed starts easing. Fed-induced recessions are not balance sheet recessions.”

The Federal Reserve’s latest economic projections show the economy growing at a pace of 0.5% in 2023, and it does not forecast a recession.

“We’ll have one because the Fed is trying to create one,” said Swonk. “When you say growth is going to stall out to zero and the unemployment rate is going to rise … it’s clear the Fed has got a recession in its forecast but they won’t say it.” The central bank forecasts unemployment could rise next year to 4.6% from its current 3.7%.

Fed reversal?

How long policymakers will be able to hold interest rates at high levels is unclear. Traders in the futures market expect the Fed to start cutting rates by the end of 2023. In its own forecast, the central bank shows rate cuts starting in 2024.

Swonk believes the Fed will have to backtrack on higher rates at some point because of the recession, but Simons expects a recession could run through the end of 2024 in a period of high rates.

 “The market clearly thinks the Fed is going to reverse course on rates as things turn down,” said Simons. “What isn’t appreciated is the Fed needs this in order to keep their long-term credibility on inflation.”

The last two recessions came after shocks. The recession in 2008 started in the financial system, and the pending recession will be nothing like that, Simons said.

“It became basically impossible to borrow money even though interest rates were low, the flow of credit slowed down a lot. Mortgage markets were broken. Financial markets suffered because of the contagion of derivatives,” said Simons. “It was financially generated. It wasn’t so much the Fed tightening policy by raising interest rates, but the market shut down because of a lack of liquidity and trust. I don’t think we have that now.”

That recession was longer than it seemed in retrospect, Swonk said. “It started in January 2008. … It was like a year and a half,” she said. “We had a year where you didn’t realize you were in it, but technically you were. …The pandemic recession was two months long, March, April 2020. That’s it.”

While the potential for recession has been on the horizon for awhile, the Fed has so far failed to really slow employment and cool the economy through the labor market. But layoff announcements are mounting, and some economists see the potential for declines in employment next year.

“At the start of the year, we were getting 600,000 [new jobs] a month, and now we are getting about maybe 250,000,” Zandi said. “I think we’ll see 100,000 and then next year it will basically go to zero. … That’s not enough to cause a recession but enough to cool the labor market.” He said there could be declines in employment next year.

“The irony here is that everybody is expecting a recession,” he said. That could change their behavior, the economy could cool and the Fed would not have to tighten so much as to choke the economy, he said.

“Debt-service burdens have never been lower, households have a boatload of cash, corporates have good balance sheets, profit margins rolled over, but they’re close to record highs,” Zandi said. “The banking system has never been as well capitalized or as liquid. Every state has a rainy day fund. The housing market is underbuilt. It is usually overbuilt going into a recession. …The foundations of the economy look strong.”

But Swonk said policymakers are not going to give up on the inflation fight until it believes it is winning. “Seeing this hawkish Fed, it’s harder to argue for a soft landing, and I think that’s because the better things are, the more hawkish they have to be. It means a more active Fed,” she said.

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Here’s what the Federal Reserve’s half-point rate hike means for you

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The Federal Reserve raised its target federal funds rate by 0.5 percentage points at the end of its two-day meeting Wednesday in a continued effort to cool inflation.

Although this marks a more typical hike compared to the super-size 0.75 percentage point moves at each of the last four meetings, the central bank is far from finished, according to Greg McBride, chief financial analyst at Bankrate.com.

“The months ahead will see the Fed raising interest rates at a more customary pace,” McBride said.

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The latest move is only one part of a rate-hiking cycle, which aims to bring down inflation without tipping the economy into a recession, as some feared would have happened already.

“I thought we would be in the midst of a recession at this point, and we’re not,” said Laura Veldkamp, a professor of finance and economics at Columbia University Business School.

“Every single time since World War II the Federal Reserve has acted to reduce inflation, unemployment has shot up, and we are not seeing that this time, and that’s what stands out,” she said. “I couldn’t really imagine a better scenario.”

Still, the combination of higher rates and inflation has hit household budgets particularly hard.

What the federal funds rate means for you

The federal funds rate, which is set by the central bank, is the interest rate at which banks borrow and lend to one another overnight. Whether directly or indirectly, higher Fed rates influence borrowing costs for consumers and, to a lesser extent, the rates they earn on savings accounts.

For now, this leaves many Americans in a bind as inflation and higher prices cause more people to lean on credit just when interest rates rise at the fastest pace in decades.

With more economic uncertainty ahead, consumers should be taking specific steps to stabilize their finances — including paying down debt, especially costly credit card and other variable rate debt, and increasing savings, McBride advised.

Pay down high-rate debt

Since most credit cards have a variable interest rate, there’s a direct connection to the Fed’s benchmark, so short-term borrowing rates are already heading higher.

Credit card annual percentage rates are now over 19%, on average, up from 16.3% at the beginning of the year, according to Bankrate.

The cost of existing credit card debt has already increased by at least $22.9 billion due to the Fed’s rate hikes, and it will rise by an additional $3.2 billion with this latest increase, according to a recent analysis by WalletHub.

If you’re carrying a balance, “grab one of the zero-percent or low-rate balance transfer offers,” McBride advised. Cards offering 15, 18 and even 21 months with no interest on transferred balances are still widely available, he said.

“This gives you a tailwind to get the debt paid off and shields you from the effect of additional rate hikes still to come.”

Otherwise, try consolidating and paying off high-interest credit cards with a lower interest home equity loan or personal loan.

Consumers with an adjustable-rate mortgage or home equity lines of credit may also want to switch to a fixed rate. 

How to know if we are in a recession

Because longer-term 15-year and 30-year mortgage rates are fixed and tied to Treasury yields and the broader economy, those homeowners won’t be immediately impacted by a rate hike.

However, the average interest rate for a 30-year fixed-rate mortgage is around 6.33% this week — up more than 3 full percentage points from 3.11% a year ago.

“These relatively high rates, combined with persistently high home prices, mean that buying a home is still a challenge for many,” said Jacob Channel, senior economic analyst at LendingTree.

The increase in mortgage rates since the start of 2022 has the same impact on affordability as a 32% increase in home prices, according to McBride’s analysis. “If you had been approved for a $300,000 mortgage in the beginning of the year, that’s the equivalent of less than $204,500 today.”

Anyone planning to finance a new car will also shell out more in the months ahead. Even though auto loans are fixed, payments are similarly getting bigger because interest rates are rising.

The average monthly payment jumped above $700 in November compared to $657 earlier in the year, despite the average amount financed and average loan term lengths staying more or less the same, according to data from Edmunds.

“Just as the industry is starting to see inventory levels get to a better place so that shoppers can actually find the vehicles they’re looking for, interest rates have risen to the point where more consumers are facing monthly payments that they likely cannot afford,” said Ivan Drury, Edmunds’ director of insights. 

Federal student loan rates are also fixed, so most borrowers won’t be impacted immediately by a rate hike. However, if you have a private loan, those loans may be fixed or have a variable rate tied to the Libor, prime or T-bill rates — which means that as the Fed raises rates, borrowers will likely pay more in interest, although how much more will vary by the benchmark.

That makes this a particularly good time to identify the loans you have outstanding and see if refinancing makes sense.

Shop for higher savings rates

While the Fed has no direct influence on deposit rates, they tend to be correlated to changes in the target federal funds rate, and the savings account rates at some of the largest retail banks, which were near rock bottom during most of the Covid pandemic, are currently up to 0.24%, on average.

Thanks, in part, to lower overhead expenses, the average online savings account rate is closer to 4%, much higher than the average rate from a traditional, brick-and-mortar bank.

“The good news is savers are seeing the best returns in 14 years, if they are shopping around,” McBride said.

Top-yielding certificates of deposit, which pay between 4% and 5%, are even better than a high-yield savings account.

And yet, because the inflation rate is now higher than all of these rates, any money in savings loses purchasing power over time. 

What’s coming next for interest rates

Consumers should prepare for even higher interest rates in the coming months.

Even though the Fed has already raised rates seven times this year, more hikes are on the horizon as the central bank slowly reins in inflation.

Recent data show that these moves are starting to take affect, including a better-than-expected consumer prices report for November. However, inflation remains well above the Fed’s 2% target.

“They will still be raising interest rates now and into 2023,” McBride said. “The ultimate stopping point is unknown, as is how long rates will stay at that eventual destination.”

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Correction: A previous version of this story misstated the extent of previous rate hikes.

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How to manage cash and stay out of debt running a business in a recession

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Melissa Bradley has helped guide thousands of business founders through challenges.

The founder of 1863 Ventures, and a serial entrepreneur and investor, says if a recession becomes economic reality and customers cut back more due to inflation, it won’t be anything new for minority entrepreneurs.

“They are concerned because of the impact it will have on customers,” Bradley told CNBC Senior Personal Finance Correspondent Sharon Epperson at the virtual Small Business Playbook event on Dec.14. “The reality is Black and brown businesses are used to being locked out of access to capital, and used to having to spend more for things, so they plan.”

With a 98% success rate during Covid among over 3,000 Black and brown entrepreneurs with whom her organization has partnered, Bradley says consistent planning and “always expecting the worst” is in a minority business owner’s DNA. “Nothing is a guarantee,” she said.

The difference now for all business owners is the need to be mindful of what customers can afford going forward. The latest retail sales report showed a much bigger drop than expected, adding to fears that the economy and consumer are rapidly slowing.

“The first thing is plan. Your financial statements tell you a lot,” Bradley said, adding that they tell you about a lot more than just the assets and liabilities. “Be laser-focused on what financials are telling you about customers,” she said.

It’s more important than ever, she says, to understand drivers of growth, and dig into the details from all the business data at your disposal, showing what customers like and don’t like, where they search and shop, and when and how often they come back.

“Keeping customers engaged and happy is the greatest gift you can give yourself this holiday season to make sure revenue keeps coming in,” Bradley said.

She has some advice for business owners on how to stay out of bad debt, make the right investments, and keep sales flowing even through a recession.

Get a handle on costs and prices

Cash is king, “or queen,” Bradley said, depending on the entrepreneur, and it’s the first thing to get a handle on in a tough economy — specifically by looking at costs and prices.

She provided the example of a spirits business that experienced a big increase in the cost of glass that resulted in the need to reevaluate pricing. All businesses need to be able to at least cover costs without dipping into the owner’s pocket to pay, and that’s become more challenging amid inflation.

Don’t dip into personal savings

Bradley stressed that a business owner should not dip into your person savings, or “borrow against your house,” to keep a business going.

“You need to make sure your business can stand on its own,” she said.

Entrepreneurs are sold on a bootstrapping mentality, “a fake it until you make it” mantra, but the reality is it’s a big mistake to bring your personal life down as your business life goes on a rollercoaster.

“Stay really focused on the numbers and know some months are going to be high and some low,” she said.

Rethink contractors and extra cash

If business owners stay on top of their financials and avoid the bad debt decisions, they may be fortunate enough to end up with extra cash. Where that money is invested can make a big difference — either good or bad.

Bradley cautioned that the “world of contractors and 1099s” has been a great thing for the small business community, but during times of uncertainty there is greater risk associated with variable costs that many contractors operate under. Variable costs are harder to predict as part of ongoing cash flow.

She advises moving more costs to the fixed cost bucket, “so you can become laser focused on it, so you don’t have a deficit at the end,” she said.

Scrutinize the use of consultants

New business formation in recent years has been at record levels and when many businesses are first starting out they rely more heavily on consultants. Bradley says now is the time to reevaluate a reliance on multiple consultants. “Every quarter, think about what key operations and processes are needed to keep the business going and how many people are touching them,” she said.

If there are too many people involved, whether internal or external, that’s a risk in and of itself and it is not the sign of an efficient business. All tasks should be centralized and aggregated in the right way, and that might mean having one person on the job rather than three consultants.

Bradley provided marketing as one example, with the tasks of script writing, social media and photography all handled by different people. The smart money move may be to hire one person for all three tasks, but she said owners are often too busy running a company to pay attention to how their money is being invested down to that level.

But being busy is no excuse.

“You can’t make it if you are not paying attention to the steps along the way, how are you spending money so it has a positive ROI over the future,” she said.

Invest a little at a time in yourself

As an investor in many businesses, Bradley sets a cap on what she will put into any entity. “You can’t fund a business forever,” she said. Setting an amount of investment and a duration of investment is part of being disciplined about the funding process.

It is critical to keep personal and business accounts separate, but just as important to know you will at some point need more money for your business and you should be paying yourself as you go — not necessarily a lot, but with consistency.

“Really stay on top of being able to pay yourself a little, and pay off those expenses,” Bradley said.

She said one of the biggest challenges business owners face is waiting too long to pay themselves. “Even if you only have $100, pay yourself $50. This is about building the muscles to sustain and grow the business over time,” she said. “Take $50 and put $25 to a bill and $25 to yourself. It is not about waiting for the big jackpot at the end of the rainbow. … It’s about making steady progress in paying down any personal debt and continuing to invest in the business,” she said.

Make changes in smaller increments

Staying focused on the numbers is likely to result in the need to make changes based on greater understanding of what is and isn’t working. Plenty of businesses have been started during recessions, Bradley said, so change is not a reason to panic.

A business owner shouldn’t be making changes all the time — that is its own form of panic — but changes should be considered in small increments. Each month, each quarter, business owners should be considering changes. And they should not be planning in terms of “next year,” Bradley said.

“What do you want to accomplish between now and the end of the year? In January? … Making changes is not a sign of failure, it’s a sign of keeping pace with customers and what you’re learning from the market,” she said.

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