What Stubborn Inflation Could Mean for the U.S. Economy

On April 10, 2024, the U.S. Bureau of Labor Statistics released the Consumer Price Index (CPI) for March, and the increase in CPI — the most commonly cited measure of inflation — was higher than expected. The rate for all items (headline inflation) was 3.5% over the previous year, while the “core CPI” rate, which strips out volatile food and energy prices, was even higher at 3.8%. The month-over-month change was also higher than anticipated at 0.4%.¹

The stock market dropped sharply on this news and continued to slide over the following days, while economists engaged in public handwringing over why their projections had been wrong and what the higher numbers might mean for the future path of interest rates. In fact, most projections were off by just 0.1% — core CPI was expected to increase by 3.7% instead of 3.8% — which hardly seems earth-shattering to the casual observer. But this small difference suggested that inflation was proving more resistant to the Federal Reserve’s high interest-rate regimen.²

It’s important to keep in mind that the most dangerous battle against inflation seems to have been won. CPI inflation peaked at 9.1% in June 2022, and there were fears of runaway inflation similar to the 1980s. That did not happen, and inflation declined fairly steadily through the end of 2023. The issue now is that there has been upward movement during the first three months of 2024.³ This is best seen by looking at the monthly rates, which capture the current situation better than the 12-month rates. March 2024 was the third month in a row of increases that point to higher inflation.

High for Longer

The Consumer Price Index measures price changes in a fixed market basket of goods and services, and some inputs are weighted more heavily than others. The cost of shelter is the largest single category, accounting for about 36% of the index and almost 38% of the March increase in CPI.⁹ The good news is that measurements of shelter costs — primarily actual rent and estimated rent that homeowners might receive if they rented their homes — tend to lag current price changes, and other measures suggest that rents are leveling or going down.¹⁰

Two lesser components contributed well above their weight. Gas prices, which are always volatile, made up only 3.3% of the index but accounted for 15% of the overall increase in CPI. Motor vehicle insurance prices made up just 2.5% of the index but accounted for more than 18% of the increase. Together, shelter, gasoline, and motor vehicle insurance drove 70% of March CPI inflation. On the positive side, food prices made up 13.5% of the index and rose by only 0.1%, effectively reducing inflation.¹¹

While the Fed pays close attention to the CPI, its preferred inflation measure is the personal consumption expenditures (PCE) price index, which places less emphasis on shelter costs, includes a broader range of inputs, and accounts for changes in consumer behavior. Due to these factors, PCE inflation tends to run lower than CPI. The annual increase in March was 2.7% for all items and 2.8% for core PCE, excluding food and energy. The monthly increase was 0.3% for both measures.¹²

Although these figures are closer to the Fed’s 2% target, they are not low enough in the face of strong employment and consumer spending to suggest the Fed will reduce interest rates anytime soon. It’s also unlikely that the Fed will raise rates. For now, the central bank seems poised to give current interest rates more time to push inflation down to a healthy level, ideally without significant slowing of economic activity.¹³

All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful. Projections are based on current conditions, subject to change, and may not come to pass.