Slow Progress on Inflation Propels Stocks

The progress on inflation has been frustratingly slow this year, but you wouldn’t know it by looking at stock market indexes. In the days after the release of the Consumer Price Index (CPI), the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite all reached new highs. What do investors like about an inflation rate that remains well-above the Fed’s target?

Although the results (annual CPI up 3.4 percent, Core CPI up 3.6 percent) did not seem like a big drop, a tenth here, two-tenths there can add up to movement in the right direction. In fact, annual core CPI has fallen to the lowest level since April 2021 and that was enough to convince investors that Fed rate cuts are coming, potentially as early as September.

For consumers, the inflation problem is different and more acute. The market euphoria over the April inflation reading comes on the heels of two, distinct periods: (1) the decade prior to the pandemic, when prices were stable and the inflation rate hovered at just below two percent and (2) the pandemic price surge, which started in 2021 and peaked in mid-2022.

In the subsequent year, pandemic supply chain issues and the jump in energy prices associated with the war in Ukraine were resolved, and those “transitory” factors, combined with the impact of higher interest rates, pushed down the inflation rate. But since last summer, inflation has been range-bound at 3 to 3.7 percent, higher than both consumers and the Federal Reserve would like to see.

One of the driving factors keeping inflation high is the cost of housing. Shelter is not only a big line item for household budgets, it is a big contributor to inflation, accounting for a third of overall CPI. Economists have long complained that the way that the government calculates shelter is problematic because it’s difficult to measure average national rent increases and for owners, officials rely on surveys that ask what their home might rent for in the market. Through April, shelter was up 5.5 percent and although more timely data on the ground indicate a slowdown in rents, until there is more meaningful progress, the Fed is expected to keep short term interest rates higher for longer.

Meanwhile, the double whammy of elevated prices and high interest rates is putting pressure on middle- and lower-income Americans. The Federal Reserve Bank of New York reported that household debt continued to rise in the first quarter, with mortgages and auto loans leading the way. Credit card balances declined slightly from the all-time high, but that follows a seasonal pattern, when consumers start a post-holiday New Year's financial diet and then use their tax refund money to pay down debt. Even with the small progress, credit card balances are near an all-time record of $1.12 trillion and have risen 45-50 percent since the beginning of 2021.

Servicing that debt has become more difficult amid a 23 year high in interest rates. According to the Fed, there is a direct line from consumers who have credit card balances, to those who max out their cards to those who become delinquent (delinquency is defined as an account that is 60 days or more past due). The share of maxed-out borrowers is approaching pre-pandemic levels and “an increasing number of borrowers missed credit card payments, revealing worsening financial distress among some households,” according to Joelle Scally, of the New York Fed.

Unfortunately for those who are under pressure, there was more bad news. Recently, a federal judge in Fort Worth, Texas, blocked a Biden administration rule that would prohibit the largest credit card companies (those with more than 1 million accounts) from charging customers late fees higher than $8. According to a Consumer Reports survey published in September, one in five American adults, an estimated 52 million people, said they had paid a credit card late fee in the previous 12 months. A preliminary injunction means the rule can’t go into effect until a hearing is held where the case can be adjudicated in greater detail.