Ep. 106 - Are We Already at 2% Inflation? | Latest PCE Data Suggests Rate Pause

Nov 01, 2023

All Signs Point to a Rate Pause at the November Fed Meeting

The latest personal consumption expenditures (PCE) inflation data and other economic indicators make a strong case for the Federal Reserve to pause its aggressive interest rate hike campaign at the upcoming November FOMC meeting. 

The core PCE price index, which strips out volatile food and energy costs, showed the annual inflation rate at 3.7%. While still high, this shows tentative signs of peaking inflationary pressures compared to the rapid price increases experienced in the past. 

With some evidence that inflation may be moderating, the Fed could afford to take a breather and assess the impacts of the substantial rate hikes enacted so far before plowing ahead with more. While the Fed remains steadfastly committed to bringing inflation back down to its 2% target, the risks of financial instability and recession from over tightening loom increasingly large. 

The central bank must weigh these risks carefully as it charts the path forward. The incoming data strengthens the case for hitting the pause button on rate hikes at the next FOMC meeting in early November. 


Consumers Under Financial Strain

However, the toll of inflation and higher rates on households cannot be ignored. While consumer spending grew 0.7% in September, incomes only rose 0.3%. People are spending more than they earn through drawing down savings and ramping up credit card balances.

The personal savings rate has plunged to 3.4%, the lowest since 2009. Credit card debt is almost 28% higher than previous years, with balances per person soaring from $4,000 to $8,000 since 2019. Over 50% of balances are going unpaid, fueling rising delinquencies.

With consumers under increasing financial stress, room for error in calibrated rate hikes has diminished. An overshoot risks recession.


Housing Market Buckling Under Rapid Rate Hikes

The housing sector continues to rapidly deteriorate as mortgage rates have spiked above 8% for the first time in over two decades. The dramatic surge in mortgage rates over the last several months has crushed housing affordability and demand. Home sales have dropped significantly, inventory of unsold homes has risen, and builders are slowing new construction with traffic and sales plummeting. 

This pullback in housing activity threatens jobs and sales for related industries including real estate agents, mortgage lenders, contractors, and more. Yet despite pleas from homebuilders and realtors, the Fed has indicated they will not pivot or relent on rate hikes to alleviate the pain in the housing market. In repeated remarks, Fed Chair Powell has stated the central bank will stay the course in aggressively raising rates to combat inflation - even if that inflicts damage on the housing industry.

While admirable to stick to their principles, the Fed risks overcorrecting and doing more harm than good for the overall economy at this point. With housing such an important sector, pumping the brakes sooner on rate hikes could help avoid pushing the economy into a deeper recession. 

However, Powell remains laser-focused on reducing inflation back to the 2% target above all else. Though this commitment is understandable, the Fed must be careful not to create unnecessary economic pain and instability simply to re-establish its inflation-fighting credibility. There are already signs of financial stress mounting among consumers and businesses. The Fed should tread cautiously and consider pausing soon to evaluate the impacts of its policy tightening so far.


The Bottom Line

The incoming data strengthens the case for the Fed to pause rate hikes in the near-term. While they remain committed to the 2% inflation goal, the risks of financial instability and recession from over tightening are rising.

With core inflation showing early signs of relief and consumers under intensifying strain, a reasonable Fed would take their foot off the brakes at the November meeting. However, Powell may forge ahead regardless in his quest to re-establish inflation-fighting credibility.