Coexistence of U.S. stubborn inflation and robust economy is likely to continue

Editor's note: He Weiwen is a senior fellow at the Center for China and Globalization. The article reflects the author's opinions and not necessarily the views of CGTN.

The U.S. inflation saw a slight improvement in April while the CPI rose by 3.4 percent year on year, compared to 3.5 percent in March, according to the U.S. Labor Statistics Bureau on Tuesday. It is a piece of good news showing the long-expected inflation easing, and bad news at the same time, showing a fall too small and too far from the FED target of 2 percent. The core CPI excluding food and energy was up 3.6 percent, 0.2 percentage point higher than the general CPI. It shows that the main reason for the lingering inflation is not international energy price rebound, rather the house price hike which was 5.5 percent higher than a year ago.

U.S. inflation fell to 3.0 percent in June, 2023, providing a jubilee to the market and augured a FED rate cut in sight. However, the CPI rose again to 3.2 percent in July and accelerated to 3.7 percent in August. The latest CPI indication of 3.4 percent shows that inflation had eased by only 0.3 percentage point over the past 8 months, meaning the U.S. inflation pressure is far from over. Hence, FED has no choice but withholding any rate cut.

On the other hand, parallel to the latest CPI release, the employment data for April shows an exceptionally strong labor market. Another 253,000 non-farm jobs were added in April, leaving the jobless rate at 3.4 percent, 0.1 percentage point down from March and the lowest level since May 1969, or in 55 years. It has provided good evidence that the relatively high inflation rate has not hindered employment growth. Instead, employment growth has pushed wage increases, contributing to a higher CPI.

The overall economic situation is also encouraging. The U.S. Bureau of Economic Analysis announced in late April that U.S. GDP grew by 1.6 percent in the first quarter of 2024, although lower than the 2.5-percent growth of 2023. The gap came mainly from a negative contribution of 0.88 percentage point from net export. Personal consumption expenditures, which constitute nearly 70 percent of the GDP, contributed 1.68 percentage points to GDP growth, with fixed investment contributing another 0.94 percentage point. The two combined results in GDP growth of 2.62 percent, and constituted the economic fundamental of the U.S. economy. The latest IMF World Economic Outlook released on April 17 estimated that the U.S. GDP will grow at 2.7 percent in 2024, slightly higher than that in 2023, yet far exceeding that of the Euro area of a meager 0.8 percent.

The coexistence of stubborn inflation and robust economy in the U.S. is by all means an exception in developed economies, and has thus left the FED in the sideline, unable to cut rates for fear of inflation rising again, nor further hike rates for fear of hurting the sound economy.

Jerome Powell, the FED chairman, delivered a speech at the Foreign Bankers Association meeting in Amsterdam, on May 14, the day the April CPI data was announced. He said that the FED is waiting for more evidence to ascertain if the current high interest rate policy has checked inflation effectively. While emphasizing the importance of keeping high interest rate for a longer time, he was not sure whether the current interest rate policy is sufficient to bring inflation down to 2 percent, the target area. If a sudden crisis in the labor market occurs, the FED will consider a rate cut. However, there is no such a danger in sight.

The stubbornly high inflation has kept the FED idle, waiting quietly for its fall. The strong labor market and performance of macroeconomic indicators have also provided the FED enough room for patience.

However, securities traders have increased the stakes for a FED rate cut, estimating an 88-percent possibility of a 25-bps rate cut as early as September.

Interest rate staying high has supported the dollar. The nominal broad U.S. dollar index has remained exceptionally high over the past three months, at 122.3898 on May 10, compared to 121.3851 on February 9.

The high inflation in the U.S. is likely to persist for the rest of 2024, with less probability of falling to the 2-percent area. It is unlikely that the FED will cut rates soon, and less likely that a jobless rate jump or economic contraction will happen in the coming months. As a result, the U.S. dollar will remain strong. As the European Central Bank is more likely to start rate cuts as early as June, the dollar-euro exchange rate will again rise slightly.

The persistently high FED rate is a disaster to the U.S. federal government as its debt service burdens climbs. During the first seven months of fiscal year (FY) 2024 (October 2023-April 2024), the federal government paid $624 billion in T-Bill interest, and the federal fiscal deficit for the whole fiscal year 2024 is likely to hit $1.8 trillion, on the basis of $1.7 trillion in FY 2023. Hence, the federal government is more anxious than businesses to see a FED rate cut.

The stubbornly high inflation and high FED rate is likely to stay on for the coming months, supporting a strong dollar and further capital inflows into the U.S., both exerting pressures on the yuan exchange rate and on capital flows into or out of China. However, the impact on world economic outlook as a whole seems limited.

(Cover via CFP)