Laura H. from Concord, NH asks: Hi Mitch, I’m looking around for signs that inflation is getting better, but frankly, I’m not seeing any. Everything still feels a lot more expensive and it doesn’t seem like the inflation picture is under control. Does that mean interest rates need to keep going up, which is in turn bad news for stocks?
Mitch’s Response:
Thanks for writing. Your question hits on two important features of the inflation picture: how consumers feel about prices, versus the rate of change of prices that the Fed cares about when setting interest rate policy. These two variables are quite different, for reasons I’ll explain below.1
The first piece – how consumers feel about inflation and prices – is based on the accumulation of price increases over the last two-plus years. Very generally speaking, prices of goods and services are about 20% higher than they were pre-pandemic, which is basically impossible for consumers to ignore. Even though prices are increasing at more normal rates now – closer to 3% – prices have been reset higher. In other words, the starting point for supposedly ‘improved’ inflation is higher, and consumers feel that.
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Just take a look at the chart below that shows the consumer price index for all items (dark red line), versus the prices of shelter (housing), and food. The things Americans care most about, arguably food and housing, went up more than the average. It makes sense that most folks don’t feel good about this.
The second part of your question connects this negative feeling about inflation with the Fed and interest rate policy, but that’s where you’ve made a slight misstep. The Fed’s goal right now is to get the rate of change of inflation down closer to 2%. They’re not trying to get prices back down to where they were pre-pandemic – that would imply deflation, which is largely bad for the economy. On the goal of getting inflation back down to 2%, the Fed has seen major progress – with the headline PCE price index posting a 3% year-over-year increase in October.4 This inflation print added to the conviction that the Federal Reserve was likely done raising rates in this cycle.
One perhaps positive note I’d add to my response is that there are some areas in the economy experiencing deflation, namely in ‘durable goods’ – these are items like appliances, furniture, and used cars. These are not the items consumers are buying every day, but there is some price relief happening that is helping the overall inflation picture. According to the Commerce Department, durable goods prices have fallen (year-over-year) for five consecutive months and were down -2.6% from their peak in September 2022. Specifically, the price of new and used cars fell -0.4% from September, home furnishings were down -0.2, and recreational goods like phones and computer equipment fell -0.4%. You may have also noticed pretty good sales at retailers this holiday season so far. I’d expect that to continue through the end of the year.
It is important to remember that factors, such as inflation and volatility, are a normal part of the ebb and flow of the markets. I believe the key is not to look for ways to eliminate it, but to develop a mental approach to dealing with it.
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Disclosure