What Strong & Persistent Inflation May Mean for the US Economy in 2024

The U.S. Bureau of Labor Statistics disclosed the Consumer Price Index (CPI) figures for March on April 10, 2024, revealing a higher-than-anticipated increase. The all items rate was 3.5% higher than the previous year, while the core CPI, discounting the volatile food and energy costs, was recorded at 3.8%. Surprisingly, the month-on-month change exceeded expectations, reaching 0.4%.(1)

Inflation Triggers Surge in CPI & Market Downturn

This unexpected surge in CPI triggered a significant downturn in the stock market, which continued to decline in the subsequent days. Economists publicly expressed their concerns over the inaccurate forecasts and speculated on how these greater figures might influence future interest rates. Although the discrepancy between the projected and actual core CPI was merely 0.1% — 3.8% instead of the predicted 3.7% — this seemingly insignificant difference indicated that inflation was more stubborn against the Federal Reserve’s high interest-rate policy than previously thought.(2)

Notably, the most critical inflation battle seems to have been overcome, as CPI inflation reached its peak of 9.1% in June 2022. Despite fears of a runaway inflation reminiscent of the 1980s, inflation declined consistently until the end of 2023. The current concern is the upward trend observed in the first quarter of 2024.(3) This is best illustrated by monthly rates, which better reflect the present situation than the 12-month rates. The third consecutive month of inflationary pressure in March 2024 indicates a potential return of higher inflation.

Persistent High Interest Rates

The impact of rising prices is directly felt by consumers, but the stock market’s primary concern is the potential implications of persistent inflation on the benchmark federal funds rate and U.S. businesses. The Federal Open Market Committee (FOMC) increased the funds rate from almost zero to between 5.25% and 5.5% from March 2022 to July 2023, as an attempt to curb the economy and contain inflation. However, with inflation seemingly stabilizing towards the Fed’s 2% target at the end of 2023, the FOMC projected three reductions of a quarter-percentage point in 2024. But now, it’s evident that the Fed will have to delay any rate cuts.(4–5)

Higher interest rates increase the cost of borrowing for businesses and consumers, which can curtail business expansion and erode profits by increasing the cost of servicing debt. This is particularly challenging for smaller companies that rely on debt to fuel growth and sustain their operations. Tech firms and banks are also particularly vulnerable to high interest rates.(6)

In theory, high interest rates should suppress consumer spending and reduce price levels by curbing demand. However, consumer spending has remained robust, with personal consumption expenditures — the standard barometer of consumer spending — registering a potent monthly growth rate of 0.8% in current dollars or 0.5% after adjusting for inflation in March 2024.(7) The labor market has remained resilient, with unemployment consistently below 4% for 26 months straight and wages increasing steadily.(8) The risk of maintaining high interest rates for an extended period is that it could decelerate the economy, but that hasn’t happened yet, complicating the Fed’s justification for rate cuts.

What’s Fueling Inflation?

The CPI tracks price fluctuations in a fixed basket of goods and services, with differential weighting assigned to various inputs. Shelter costs, the single largest category, represent about 36% of the index and nearly 38% of the March CPI increase.(9) The silver lining is that shelter cost measurements — mainly actual rent and the estimated rent homeowners might earn if they rented their properties — often lag behind current price changes, and other metrics suggest a leveling off or decline in rents.(10)

Two smaller components also played a significant role in the inflationary increase. Gas prices, although always fluctuating, constituted only 3.3% of the index but contributed to 15% of the overall CPI increase. Motor vehicle insurance prices, representing just 2.5% of the index, accounted for over 18% of the increase. Combined, shelter, gasoline, and motor vehicle insurance accounted for 70% of the inflation in March. On the brighter side, food prices, which constituted 13.5% of the index, increased by a mere 0.1%, effectively dampening inflation.(11)

Although the Fed keeps a close eye on the CPI, it prefers the personal consumption expenditures (PCE) price index as its inflation measure. PCE inflation, with less emphasis on shelter costs, a wider range of inputs, and accounting for changes in consumer behavior, generally runs lower than CPI. The annual increase for all items in March was 2.7% and 2.8% for core PCE, excluding food and energy, with a monthly increase of 0.3% for both measures.(12)

While these statistics approach the Federal Reserve’s 2% objective, they are not sufficiently low, considering the robust employment and consumer spending scenarios, to indicate any imminent reduction in interest rates by the Fed. Also, it seems that the Fed will hike rates in the near future. The central bank, at this juncture, appears to be in favor of allowing the prevailing interest rates more time to drive inflation to a stable level, ideally without any major slowdown in economic activity.(13)

Investing inherently comes with risks, including the potential loss of the principal amount, and there’s no assurance any investment strategy will yield success. Current projections are based on the existing conditions and are liable to change, with no certainty of realization.

1) U.S. Bureau of Labor Statistics, 2024
2) The New York Times, April 10, 2024
3) U.S. Bureau of Labor Statistics, 2024
4) Federal Reserve, 2023
5) Forbes, December 5, 2023
6) The Wall Street Journal, April 15, 2024
7) U.S. Bureau of Economic Analysis, 2024
8) U.S. Bureau of Labor Statistics, 2024
9) U.S. Bureau of Labor Statistics, 2024
10) NPR, April 18, 2024
11) U.S. Bureau of Labor Statistics, 2024
12) U.S. Bureau of Economic Analysis, 2024
13) Bloomberg, April 19, 2024

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