The last batch of inflation data that Federal Reserve officials will see before next week's policy meeting has been released, and the results are not optimistic. According to several independent reports this week, the Commerce Department's index shows that the inflation signal the Federal Reserve relies on shows that prices continue to rise, and the rate is still significantly higher than the central bank's 2% annual target.

The report points out several notable problems. There is still a large amount of capital in the financial system, which provides consumers with lasting purchasing power. In fact, consumers are spending more than they earn, a situation that is neither sustainable nor conducive to falling inflation. Consumers are using their savings to finance these spending, creating a dangerous scenario that may not be present but may be in the future.

Combining these factors, the Federal Reserve is likely to remain cautious and will not start cutting interest rates anytime soon.

Joseph LaVorgna, chief economist at SMBC Nikko Securities, said, “Just a large amount of spending creates demand, which in itself is a stimulus. With unemployment below 4%, it's not surprising that prices aren't falling. Spending figures won't drop anytime soon. As a result, we are likely to face a continuing inflationary scenario.”

In fact, according to data released by the Bureau of Economic Analysis on Friday, expenses exceeded income in March, for three of the past four months, while the personal savings rate fell to 3.2%, the lowest level since October 2022.

Meanwhile, the personal consumption expenditure price index, the Federal Reserve's key measure for determining inflationary pressure, reached 2.7% in March, including all items, while the core index excluding more volatile food and energy prices remained at 2.8%.

The Ministry of Commerce reported a day ago that the core inflation rate for the first quarter was 3.7%, and the overall inflation rate was 3.4%. Meanwhile, real US GDP growth has slowed to 1.6%, far below consensus expectations.

Potentially dangerous scenarios

The stubborn inflation data raised several ominous signs that the Federal Reserve might have to keep interest rates high for longer, threatening the desired “soft landing” of the economy. If inflation continues, the central bank may have to consider not only maintaining current interest rates, but also future rate hikes.

LaVorgna added: “Currently, this means that the Federal Reserve will not cut interest rates. If inflation does not fall, the Fed may have to raise interest rates at some point or keep interest rates at a high level for a longer period of time. Will this eventually lead to a 'hard landing'?”

The current US inflation problem first appeared in 2022 and has multiple sources.

At the beginning of inflation, it was mainly due to supply chain disruptions. Federal Reserve officials believed that once shipping companies and manufacturers had a chance to catch up, these problems would disappear as COVID-19 restrictions were relaxed.

But even though the economic crisis caused by the COVID-19 pandemic is over, Congress and the Biden administration continued to spend heavily, and the budget deficit reached 6.2% of GDP at the end of 2023, the highest level in non-COVID-19 years since 2012, and is usually associated with recession rather than expansion.

Furthermore, the labor market remains tight. The ratio of job vacancies to available workers once reached 2 to 1; it is still around 1.4 to 1, which also helps maintain high wage pressure.

Even as demand shifts from goods to services — the normal state of the US economy, inflation remains high, thwarting the Federal Reserve's efforts to curb demand.

According to Mike Sanders, head of fixed income at Madison Investments, Federal Reserve officials originally expected that inflation would ease this year as housing costs drop. Although most economists still expect an increase in supply to depress housing-related prices, new problems have arisen in other areas. For example, inflation on core personal consumption expenditure (PCE) services other than housing reached an annualized rate of 5.6% over the past three months.

Although the Federal Reserve's interest rate hike was intended to curb demand, demand is still strong, which fuels inflation and shows that the central bank's ability to reduce the rate of price increases may not be as strong as expected. “If inflation remains high, the Federal Reserve will face a difficult choice: push the economy into recession, abandon expectations of a soft landing, or tolerate inflation of more than 2%,” Sanders said. For us, accepting higher inflation is a more prudent choice.”

Concerns about hard landings

So far, although the economy has avoided the widespread damage that the inflation problem may cause, some obvious cracks have emerged. Credit defaults have reached their highest level in ten years, and Wall Street is increasingly worried that there may be more market fluctuations in the future.

Inflation expectations are also rising. According to the closely watched University of Michigan consumer sentiment survey, one-year and five-year inflation expectations reached the highest annualized rates of 3.2% and 3% since November 2023, respectively.

J.P. Morgan CEO Dimon also showed concern about the US economic outlook this week, from calling the US economic boom “unbelievable” on Wednesday to telling the media the next day that he is worried that high government spending is causing an inflation problem that is more difficult to solve than the current one.

Dimon said, “This has boosted a lot of economic growth, and this may have other consequences. Inflation may not go away as people expect. So I'm considering the range of possible results. We may achieve a 'soft land', but I'm more concerned that it may not be as moderate and that inflation may not be as trending as people expected.”

He estimated that the market prices the probability of a soft landing at 70%. “I think it's actually only half.”