Was the dragon killed? Or just wounded?
Inflation has been the scourge of the economy for the past three years. The percentage rose from 1.4% when President Biden took office in 2021 to a high of 9% about 18 months later. The Fed made its goal by raising interest rates quickly, and it seemed to work. By September, inflation had fallen to 2.4%, roughly in the normal zone.
Then, an upward jump. The latest data shows that inflation rose to 2.6% in October. This could be a spot on an x-ray that turns out to be nothing. Or it could signal that inflation is starting to return, which would confound expectations about interest rates, financial markets, and the policies of the incoming Trump administration.
October’s inflation surge was not a fluke due to hurricanes or other one-time anomalies. The most important categories of goods and services rose, including food, energy, rent and vehicles. This came one month after the Federal Reserve declared its victory over inflation. In September, the Fed reversed its monetary policy and began cutting interest rates, signaling that it was time to worry about maintaining growth rather than cutting rates.
The Fed is staying the course for now. He cut short-term interest rates again on November 14 and may do so again at the next policy meeting in December. But the odds of further interest rate cuts are declining, with policymakers waiting for more laboratory results in the form of upcoming inflation data.
“Inflation may soon be front-page news again,” Capital Economics declared in a November 13 analysis. The forecasting firm says the current inflationary trend is OK, but the future outlook is more worrying – largely because of what Donald Trump plans to do once he takes office next January.
At least two items on Trump’s agenda are inflationary: new tariffs on imports and mass deportations of illegal immigrants. Tariffs are taxes that directly raise the cost of imported goods. Deporting immigrants would reduce the size of the labor force, especially targeting low-wage workers. Replacing them with workers who might demand higher wages — or with more expensive machinery — would raise costs one way or another, with producers passing on as much as possible to consumers.
A third concern about inflation is Trump’s desire to cut taxes further, which can have a stimulative effect by putting more money in people’s pockets, boosting spending and demand, and sometimes causing prices to rise.
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“Given everything that President-elect Trump has promised so quickly — such as raising tariffs, cutting taxes further, and reducing immigration — one can easily expect inflation to accelerate again next year,” said Bernard Baumol, chief global economist at the Economic Outlook Group. , wrote on November 13. “The Federal Reserve is now in real trouble.”
The stock market has been booming since Trump won a second term on November 5. But the bond market is registering concern. Since the Fed began cutting short-term interest rates in mid-September, long-term interest rates have gone in the opposite direction, with 10-year Treasury rates rising by eight-tenths of a percentage point. Interest rates on mortgages and most consumer and business loans track 10-year Treasuries, so borrowing costs for almost everyone have been rising over the past couple of months.
Bond investors appear to be betting that inflation will rise again, and are thus demanding a higher rate of return to hold on to their money. Inflation pushes long-term interest rates higher in two ways: If the Fed had to again start raising short-term interest rates to fight inflation, that could affect long-term interest rates. Higher rates are also a hedge against money losing value faster when inflation is higher.
If all this happens, Trump could face headwinds while in office. Consumers are deeply embarrassed by inflation, which clearly contributed to voters’ rejection of incumbent Democrats and the defeat of Kamala Harris in the presidential election this year. Consumer confidence has slowly improved as inflation has declined, but it may decline again if people see another wave of inflation looming.
Many consumers who want to buy a home or car at affordable prices have been waiting and hoping for lower prices. This may not happen anytime soon, which will especially exacerbate rising housing costs. If voters take their inflationary frustrations onto Trump, he could end up politically weak just like President Biden, whose popularity declined as inflation set in and never recovered.
Trump has some control over the type of economy he will preside over. He can impose more tamed customs and deportation policies than he promised when he was a candidate, which may generate relief in the markets and reduce inflation expectations and interest rates. Resuscitation is a possibility but not a certainty.
If Trump learns anything from Biden, he will do anything to prevent it.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman.
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