MW The Fed hasn't tamed inflation - and the stock market has yet to figure that out
By Peter Morici
Stocks can handle moderate inflation as long as economic growth persists
Either the Federal Reserve lets interest rates settle much higher than pre-pandemic levels or we endure more inflation.
The Federal Reserve should remain cautious about inflation. In September, the annual change in the U.S. Consumer Price Index fell to 2.4%, but core inflation, which strips out food and energy, remained high at 3.3%. Prices for essentials such as health care, car and homeowners' insurance and amusements like concert tickets continue to rise briskly. Lower oil prices pulled down headline inflation but that could easily reverse.
In China, falling property values, consumer pessimism and overinvestment are pushing down prices for manufacturers globally, but those pressures on U.S prices appear waning. In September, non-energy goods subtracted just 0.2% from the CPI. Meanwhile, non-energy services, which account for 61.3% of the CPI, were up 4.7% - shelter rose 4.9% and other non-energy services advanced 4.3%, for example.
Four points bear mentioning:
First, price surges have lasting effects on consumer psychology. New York Federal Reserve Bank, Conference Board and University of Michigan surveys of one-year expected inflation to average above 3%, in line with core inflation and above the Fed's 2% target.
Expectations affect both union and individual worker postures in wage negotiations and business planning. Consider the Boeing $(BA)$ workers' demands and the richness of the firm's multiyear contract offer.
Second, federal policymakers should admit to their mistakes or risk repeating them - and not getting credit for their successes. For instance, the Trump and Biden administrations combined spent $4.5 trillion for COVID-19 pandemic relief, and the Fed purchased a similar amount of bonds and other securities, greatly expanding the U.S. money supply.
Those moves jacked up consumer demand and took headline inflation to 9.1% in June 2022. Pandemic relief was excessively generous, and workers were slow to return when shutdowns ended, prolonging upward pressures on wages and prices.
Instead of admitting to overspending, the Biden administration further pushed up the federal deficit with the Chips and Science Act and the Inflation Reduction Act. This year, the federal budget gap is 7% of GDP, versus 4.6% just before COVID.
With businesses ramping up spending on artificial intelligence, additional private investment and federal debt will compete for new savings in financial markets. Either the Fed lets interest rates settle much higher than pre-pandemic levels or we endure more inflation.
U.S. Vice President Kamala Harris, the Democratic presidential candidate, pins inflation partly on big landlords using algorithms to set rents and corporate price gouging, for example by supermarket chains. Yet many economists find supermarket margins have not trended upward and not tied to recent food price spikes. The New York Fed found grocery prices were primarily driven by rising wages and fluctuating commodity prices.
Championing bans on algorithmic pricing and scapegoating businesses may score well with more progressive voters but limit Harris' appeal with moderate, swing voters. Algorithmic pricing is common - consider the airlines and Amtrak. Banning it would likely result in less-efficient fare adjustments to ration scarcity during peak demand and fewer discounts when seats are plentiful, limiting opportunities for lower-income travelers.
Nowadays, U.S. GDP is back on the trend forecasted prior to the pandemic, and the economy continues to robustly add jobs. In political "swing states," unemployment is generally below pre-COVID levels. Yet the Biden administration gets poor marks on handling the economy, and Harris struggles against former President Donald Trump, the Republican presidential nominee, in swing states.
The third point of note is that economics invariably bends to political agendas. A cottage industry has emerged to discredit "neo-liberal economics" and lend credibility to New Monetary Theory notions that large deficits financed by printing money may fund generous social programs.
Research by the Brookings Institution attempts to blame supply shortages for higher U.S. inflation, "especially a rise in company margins" - and not excessive COVID relief policies.
Margins rise when supplies are constrained. But now many producers of non-essential goods-for example Ikea and Nike $(NKE)$-are yielding to pressure to lower their prices.
To avoid chronic tradeoffs between high interest rates and inflation, the federal government must either cut entitlements, which compose more than 60% of its spending, or impose taxes more in line with those paid in Europe.
The fourth point: a growing economy with moderate inflation is good for stocks. The 25 years prior to the Global Financial Crisis was a period of elevated CPI inflation, which averaged 3.1%. During that time the S&P 500 SPX gained 13.7% a year on average. Over the past two years, inflation has averaged 3.1% while stock prices have increased at a more than 20% annualized pace. Stocks gains are likely to moderate going forward, but economic growth and profits are what matter most to keep share prices going up.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
More: Inflation is going higher, this market strategist says. Here's his master plan to profit from it.
Plus: Whether you vote for Harris or Trump, it's a sure bet the stock market will thrive
-Peter Morici
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November 02, 2024 13:55 ET (17:55 GMT)
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