National Retail Federation chief economist Jack Kleinhenz said the pace of inflation and how the United States Federal Reserve responds to it will play a major role in the economy this year as markets watch for when the United States Federal Reserve might make interest rate cuts.
In NRF Monthly Economic Review, Kleinhenz pointed out January’s 3.1% year-over-year inflation as measured by the Consumer Price Index was an improvement from December’s 3.4% rate but remained above the Fed’s target of 2%. The Personal Consumption Expenditures Price Index, the Fed’s preferred measure of inflation, came in at 2.4% in January, compared with 2.6% in December.
A key factor in inflation determinations is the difference between services, which were up 4.9% year over year in January, and commodity-based prices including retail goods, which were up only 0.1% for the same period in the CPI measure. Following a surge in spending on goods while consumers were stuck at home during the initial months of the pandemic, spending has been moving back toward services. As of the 2023 fourth quarter, 65% of consumer spending was on services, short of 68% in the 2019 fourth quarter but up from the pandemic low of 63% in April 2021.
Overall, consumer spending dipped in January because of a decline in spending on and lower prices for goods, even though there was a rise in services spending and prices for services gained.
NRF noted that, recently, Fed Chairman Jerome Powell said non-housing services — including health care, financial services and insurance, restaurants and transportation — are important to consider as a guide to inflationary trends. Non-housing services constitute 55% of the PCE index and have labor as their highest cost. Powell said services face a challenge because of the current labor market, which has been subject to high wages and job growth, elevated vacancies and an imbalance between supply and demand.
In January, the Fed left interest rates unchanged for the fourth straight time during a period of some seven months, and its Open Markets Committee indicated that employment and inflation goals are becoming better balanced. However, as it looks at the economy, the committee added reducing interest rates would be inappropriate until it has gained greater confidence inflation is moving sustainably toward 2%.
Kleinhenz said he expects the Fed to hold rates steady in March, then cut rates by a quarter of a percentage point either at the open market committee’s meeting at the end of April or at its June meeting. If inflation indicators remain stronger than preferred, a mid-year move is more likely. Subsequent cuts in September and December could bring the total reduction in rates to between three-quarters of a percentage point and a full point, he maintained.
“The persistent strength in services spending and inflation in the service sector strongly suggest that the Fed will likely be cautious about rate cuts,” Kleinhenz said. “With the U.S. economy’s strength resting heavily on household spending, all eyes are on the consumer and how consumers will respond the next few months to the Federal Reserve’s ongoing efforts to tame inflation. While inflation is down from its peak, it has slowed less than expected and is still an important problem that remains to be solved.”
