What is it about this economy that resists the normal ways we understand the world around us? In July, inflation froze after nearly a year and a half of relentless increases, with a sharp decrease in oil and gas prices cooling the economy. In the days following that report, the Dow Jones rose some 1,500 points and the economy seemed to be — finally — on a better footing. Today, the federal government released its inflation report for August, which showed that things hadn’t changed all that much from the previous month, with the Consumer Price Index coming in at 8.3 percent annually but rising just one-tenth of a percentage point month over month, again driven down by the price of gas. This time, however, the Dow dropped nearly 1,300 points, and Wall Street now has doubts about the health of the economy going forward. Two reports, essentially the same outcome, totally different reactions. The reality is that there are no easy ways to get inflation down, and the solutions at hand may make the problem worse, at least for the coming months. Here’s what’s happening:
Rents are the new gas
From March through June, the price of gas was the biggest bogeyman in the economy. Even if you relied on public transportation, you could see it rising every time you passed a gas station, saw a heating bill, or noticed a handwritten sign at a restaurant blaming higher prices on rising shipping costs. After all, Russia’s invasion of Ukraine was shaking the very foundation of the world economy and constrained how much gas there was to go around. But after peaking in June, demand cratered, fears about the economy sent the price of oil lower, and the White House worked to pump up the supply by depleting the country’s emergency reserves. Since our economy runs on fossil fuels, that meant that less and less money was going to pay for that energy. The problem is the money didn’t stay put in people’s bank accounts so much as it migrated toward people’s monthly rent or mortgage payments.
I’ve written about the Blob-like nature of this inflationary period as far back as February. It moves from one part of the economy to the other, sucking up money where it can. When Omicron spiked in December and people stopped going out, all of a sudden grocery prices rose. As people drove more during the spring and summer, so went the price of gas. Now people are moving — a lot of people. Rental vacancies are at their lowest since 1984; the rise in mortgage rates, now near 6 percent for a 30-year loan, haven’t really done a lot to bring down the cost of buying a home. That means a whole lot of people out there are looking for a place to live right now, and odds are good they have more money to throw at the problem than you do. It also shows that inflation has come for the so-called “core” parts of the economy, which the Fed pays closer attention to. I’m fact, the core gauge of inflation rose by 0.6 percent, much higher than predicted, with shelter making up nearly half of that rise.
The Fed is trapped
It’s important to remember that this single inflation report — just like any individual economic report — matters only as part of a bigger picture. What really matters now is what comes after, especially what the Federal Reserve will do. Since Wall Street had predicted inflation would be lower last month, this report was a nasty surprise. It also means the central bank doesn’t have a lot of wiggle room to fix it.
Here’s a quick refresher on recent history: Last year, when prices started to rise, the Federal Reserve dismissed them as transitory and kept on with a giant bond-buying program while keeping borrowing costs near zero, blaming supply chain snarls, and making a bet that the COVID vaccines would fix the economy. That didn’t happen. Inflation peaked above 9 percent in June, and the central bank’s chair, Jerome Powell, has had to deal with questions about why he was so behind the curve. Influential investors like Bill Ackman have made the case that Powell needs to keep rates higher longer in order to kill inflation. No matter how you look at it, it appears we’re still not anywhere near out of the woods when it comes to the economy stabilizing.
So the drop in stock prices today was the biggest since June 2020, when we were just a few months into the coronavirus pandemic. It was also a reflection of a lack of optimism since almost all of the selling came at the end of the day, after investors had time to digest the report. “This late-day sell-off with increasing volume underscores that the market is fearful that the Fed leads us into a recession and/or ‘breaks’ something,” Quincy Krosby, chief market strategist for LPL Financial, said in a note.
Most commenters are focused on next week’s Fed meeting where the question is whether Powell will hike rates by half a percentage point or keep up the fastest pace of increases in 40 years. In reality, it was always unlikely that anything the inflation report said would have caused the Fed to go gentler on the economy, and the importance was always on what would come after. Now, though, there are calls to jam up rates even higher and go even longer than ever before. As always, it’s possible that could break inflation before it breaks the economy, and it’s up to Powell to decide if the cost — in lost jobs and the higher odds of a recession — is worth it.