Which came first: the good economy or the confidence? Feeling good about our prospects gets us to spend money. But for us to spend, we need confidence in the outlook.
How we feel and how we act often contradict each other.
Consumer confidence surveys have been at levels consistent with a poor economy. Some economists wonder why this is the case, considering we did not have a recession. Unemployment is near a 60-year low. People have been spending at an above average pace the last few years, despite feeling the economy is bad.
The problem is inflation. And inflation makes us feel worse. We see that visible hit to purchasing power at the store (or online) each day.
Prices hit the highest level of inflation in 40 years. In turn, the Fed raised interest rates at the fastest rate since the 1970s.
Harvard economist Judd Cramer says today’s inflation data does not capture reality for individuals. This explains why people do not feel as good.
In a recent paper, he cites how the consumer price index was calculated in the 1980s and how it differs from today. It dives into housing costs and how, prior to 1983, mortgage rates were included in the price index. Today, we use a rent calculation for CPI that does not factor in mortgage rates. After going from 3% to 7% mortgage rates, this is a significant cost to homebuyers. The same goes for financing a car or larger purchase.
The chart below demonstrates how fast the mortgage payment has risen for first time homebuyers, nearly $1,000 above the prior 40-year trend.
Alternative inflation data provided a peak into the future in the last few years. Before official inflation data went up, wages and rent started moving higher. On the way back down from late 2022, both declined in advance of the official measures.
Lately, the annual change in rental rates has fallen to the pre-2020 average. Apartment List shows a decline over the past year. This leads the official data measures. Unfortunately, rental data misses higher mortgage costs that impact new homebuyers.
On the other hand, the January inflation data challenged the downward price trend. The Super Core inflation focuses on services, a key metric for the Fed and Chairman Powell. It had been falling but is back up to nearly a 6% rate over the past 6 months.
There is no doubt that inflation has been the theme of this cycle, and the last few years have included both a huge rise and decline in inflation. It took 18 months, but the fall from 9% to 3% inflation was relatively smooth. Some economists worry that the last mile of inflation, falling from 3% to 2% will not be as easy.
There is also a possibility that the target inflation rate will be moved up to 3%. We have all learned in markets that the rules by policymakers can change in the middle of the game. During his testimony in front of Congress this past week, Chairman Powell said the committee “is not looking for inflation to go all the way down to 2%, but we do need more evidence.”
As it stands today, people do not feel great about the economy for specific reasons. Inflation is still relatively high, and interest rates to finance big purchases remain above average.
The Fed has a challenge ahead. Interest rate cuts are expected by June, but the data needs to cooperate for the cuts to happen. This might alleviate pressure on consumers and hopefully change the feelings on their confidence. Still, the hot economy could push rate cuts even further away.
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