Despite appearing to ease, inflation remains a significant issue.

• Despite the easing of inflation measures, the high cost of goods and services remains a burden for individuals, businesses, and policymakers in the U.S. economy.
• Food inflation has surged 22% since prices began to rise in early 2021. Eggs have increased by 87%, auto insurance has soared nearly 47%, and although gasoline prices have recently decreased, they are still up 16%.
• Although the current debt delinquency rate of 2.74% is the highest in nearly 12 years, rising debt has not yet become a significant issue.
• At its upcoming policy meeting on Nov. 6-7, the Fed must make a crucial interest rate decision amidst the turbulent inflation landscape.

Although the Federal Reserve is close to achieving its inflation target, the persistence of high prices for goods and services throughout the U.S. economy remains a challenge for individuals, businesses, and policymakers.

Although recent price reports on goods and services are stronger than anticipated, the rate of inflation over the past year is approaching the central bank's 2% target.

The Bureau of Economic Analysis is expected to release inflation rate figures later this month, which may be close enough to get rounded down to the 2% level, according to Goldman Sachs' recent estimate.

Inflation is a complex issue that cannot be fully understood by any single measure, and according to many metrics, it remains above the comfort level of most Americans and some Fed officials.

San Francisco Fed President Mary Daly, like many of her colleagues, highlighted the easing of inflation pressures on Tuesday but emphasized that the Fed is not declaring victory and is not content to rest on its laurels.

She emphasized to the group at the New York University Stern School of Business that progress towards our goals is not guaranteed, so we must remain vigilant and intentional.

Inflation is not dead

While strolling near her home, Daly recounted a recent incident where a young man with a stroller and dog asked her if she was declaring victory over inflation. She clarified that she had not been waving any banners regarding this matter.

The Fed faces a dilemma: if inflation is increasing, why are interest rates remaining high? On the other hand, if inflation has not been controlled, why is the Fed lowering rates?

Daly viewed the Fed's half percentage point reduction in September as a "right-sizing" policy aimed at aligning the current rate climate with inflation that had decreased significantly from its peak in mid-2022, while also indicating signs of a softening labor market.

It is difficult to convince people that inflation is decreasing, as shown by the young man's query.

The rate of inflation, which is the 12-month view that garners headlines, and the cumulative effects that a more than three-year run has had on the economy are the two key things to remember when it comes to inflation.

Looking at the 12-month rate provides only a limited view.

In September, the annual rate of CPI inflation was 2.4%, a significant improvement from the 9.1% peak in June 2022. Although the CPI measure is the most widely followed, the Fed places more emphasis on the personal consumption expenditures price index from the Commerce Department. According to Goldman, the inputs from the CPI that contribute to the PCE measure are only a few hundredths of a percentage point away from 2%.

In March 2021, inflation surpassed the Fed's 2% target, but Fed officials dismissed it as a "transitory" result of pandemic-specific factors that would soon dissipate. In his annual policy speech at the Jackson Hole, Wyoming summit in August, Fed Chair Jerome Powell joked about the "good ship Transitory" and its passengers during the early stages of the inflation spike.

Since the initial period, inflation has not been temporary, and the all-items CPI reading has increased by 18.8%. Food inflation has increased by 22%, eggs have increased by 87%, auto insurance has increased by almost 47%, and gasoline, although on a downward trend, has still increased by 16% from then. Additionally, the median home price has increased by 16% since Q1 of 2021 and 30% from the beginning of the pandemic-fueled buying frenzy.

While some broad measures of inflation, such as CPI and PCE, are decreasing, others remain unchanged.

Despite the Atlanta Fed's measure of "sticky price" inflation remaining at a 4% rate in September, the "flexible CPI," which includes food, energy, and vehicle costs, was in outright deflation at -2.1%. This indicates that prices that don't change much are still high, while those that do, such as gasoline, are falling but could potentially reverse direction.

Another crucial aspect to consider is the "core" inflation rate, which is calculated without food and energy prices, which tend to fluctuate more than other items. According to the CPI measure, the core inflation rate was 3.3% in September, while the PCE index recorded a slightly lower rate of 2.7% in August.

Historically, Fed officials have considered core inflation as a better measure of long-run trends, but lately they've been focusing more on headline numbers. This makes the recent inflation data even more concerning.

Borrowing to pay higher prices

Despite the recent spike in inflation, American consumers have continued to spend excessively, grumbling about the rising cost of living.

In the second quarter, consumer spending was close to $20 trillion at an annualized pace, according to the Bureau of Economic Analysis. In September, retail sales increased by 0.4%, with the group that feeds directly into gross domestic product calculations up by 0.7%. However, year-over-year spending increased by only 1.7%, which was below the 2.4% CPI inflation rate.

A growing portion of spending has come through IOUs of various forms.

Household debt increased by 3.2% in the second quarter of this year, reaching a total of $20.2 trillion, up $3.25 trillion from the same period last year, according to Federal Reserve data.

Although the increasing debt has not yet become a significant issue, it is approaching that point.

Although the current debt delinquency rate of 2.74% is the highest in nearly 12 years, it is still slightly below the long-term average of around 3% in Fed data going back to 1987. However, a recent New York Fed survey revealed that the perceived probability of missing a minimum debt payment over the next three months increased to 14.2% of respondents, the highest level since April 2020.

And it's not just consumers who are racking up credit.

The usage of small business credit cards has increased by more than 20% compared to pre-pandemic levels and is approaching its highest level in a decade, according to Bank of America. The bank's economists predict that the pressure may ease as the Fed lowers interest rates, but the magnitude of the cuts may be uncertain if inflation proves stubborn.

Despite the challenges faced by small businesses, they have not kept up with the 23% inflation increase since 2019, according to BofA.

Despite the fact that sentiment is generally downbeat at small firms, the September survey from the National Federation of Independent Business revealed that 23% of respondents still view inflation as their primary concern, which remains the top issue for members.

The Fed's choice

At its upcoming policy meeting on Nov. 6-7, the Fed must make a crucial decision amidst the turbulent inflation landscape.

In September, policymakers reduced their baseline interest rate by 50 basis points. However, instead of anticipating lower rates, markets have shown a higher trajectory.

Since the cut, the rate on a 30-year fixed mortgage has increased by approximately 40 basis points, according to Freddie Mac. Similarly, the 10-year Treasury note has also risen by a similar amount. Additionally, the 5-year breakeven rate, which is a bond market inflation gauge that compares the 5-year government note to the Treasury Inflation Protected Security of the same duration, has increased by about a quarter point and recently reached its highest level since early July.

Nikko Securities has been advocating for the Fed to pause its cuts until it has more clarity on the current situation. The firm believes that with stock market prices reaching new records and the Fed shifting into easing mode, softening financial conditions could lead to inflation increasing. Atlanta Fed President Raphael Bostic has indicated that a November pause is a possibility he is considering.

Lower interest rates will likely ease financial conditions and increase wealth through higher equity prices, according to Joseph LaVorgna, SMBC chief economist and former senior economist in the Donald Trump White House, who wrote in a note Friday. However, an inflationary backdrop is expected to persist.

Daly, the San Francisco Fed president, encountered uneasy young men who hinted at the possibility of the Fed making a policy mistake.

"Daly stated during her New York talk that she believes we can progress towards a world where individuals have the opportunity to catch up and then advance. She shared this sentiment with a young father on the sidewalk, considering her mission accomplished once she conveyed her version of success to him."