Oddball Inflation Drivers Undermining Rate Drops

Inflation isn’t a simple thing and the Federal Reserve’s response to it isn’t either as price increases are now always transitory. To assume that the Fed will always have the most desired response to inflation is unrealistic. There are multiple factors that could undercut the hope for rate reductions this year.

As a reminder, the current Fed has shown itself capable of misreading the economy. Those “transitory” price increases kept going up, and eventually so did the interest rates. Even when supply constraints that likely caused much of the inflation wouldn’t necessarily respond to that type of pressure. Even when there’s evidence that many companies used inflation as an excuse for pricing power to boost profits, as the Financial Times just reported, It pointed to the continued elevation of consumer goods prices, even as the Producer Price Index has been retreating.

“For 30 years before Covid, inflation had gotten so grounded that companies had gotten conditioned into thinking that they didn’t have any pricing power,” Richmond Fed president Thomas Barkin told the Financial Times in an interview. “You had globalization, favorable demographics. No one wanted to go into Home Depot with a price increase.”

One factor that contributed to December’s rise in inflation was the cost of shelter, which was responsible for half the increase. Shelter costs are a lagged metric as they depend on previously signed leases and don’t necessarily represent the current costs. “In other words, we already know that shelter inflation is going to continue to decline based on historical data, which means there is some ‘baked in’ future decline in inflation that is nearly inevitable,” Xander Snyder, senior commercial real estate economist at First American Commercial Real Estate, said in an emailed note. But that doesn’t necessarily matter when they push inflation up.

Healthcare costs were also a factor, said Reuters. “Services inflation remained sticky, gaining a solid 0.5%, which also reflected a 0.6% increase in healthcare costs,” they wrote. Both shelter and services, including healthcare, remain in inflation calculations, unlike the notably volatile energy and food sectors.

In an additional story, Reuters pointed to another factor, auto insurance. “The behavior of the MVI (motor vehicle insurance) component of the CPI has truly been remarkable, and I don’t see any evidence of near-term relief,” Tom Simons, U.S. economist at Jefferies, told Reuters in an email. It rose by 20.3% between December 2022 and 2023.

Put differently, it might be that the country will see multiple rate cuts in 2024. But it’s also conceivable that it won’t if inflation remains stubbornly high because of these factors.