When most Americans retire, Social Security becomes an indispensable source of income. Based on surveys conducted over the past 20 years by national pollster Gallup, between 80% and 90% of retired respondents say their Social Security benefits provide a “major” or “minor” source of income.
Given the important role the program plays in keeping our nation’s retired workforce out of poverty, it should come as no surprise that Social Security’s most anticipated annual announcement is its cost-of-living adjustment (COLA).
Image source: Getty Images.
Social Security’s COLA is the program’s most anticipated annual announcement
Social Security’s COLA is the “raise” recipients receive most years that accounts for the rising prices of goods and services, which you probably know better as inflation. COLA is actually the mechanism designed to help Social Security’s more than 66 million beneficiaries maintain their purchasing power over time.
Before 1975, inflation-based adjustments to payouts were made randomly and had to be approved by special sessions of Congress. Since 1975, the COLA has been calculated annually from the program’s inflationary peg, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The CPI-W consists of a large basket of goods and services, each with its own percentage weighting. The importance of each component having its own weighting is that it allows the CPI-W to be expressed as a single number, which can then be easily compared with previous months or the year-ago period to determine whether prices have risen (inflation ) or decreased (deflation) as a whole.
Except for three years since 1975, Social Security beneficiaries have received a “raise” the following year. And if you were wondering why I put “increase” in quotes, it’s to represent that this increase in monthly benefits is designed to keep pace with inflation and is not akin to an increase you’d get from a employer that could exceed prevailing inflation.
Image source: Getty Images.
Your 2024 Social Security COLA could be a dud
This year, Social Security recipients are enjoying a truly historic COLA. The 8.7% “raise” they received is the largest on a percentage basis in 41 years. In nominal dollar terms, the average monthly payout increase of $146/month for retired workers is the largest on record.
Unfortunately, your 2024 Social Security cost-of-living adjustment, which is still seven months away from being announced, looks set to disappoint — and there’s an extensive history of evidence to support that claim.
The issue is that U.S. inflation is likely to decline during the second half of 2023. That’s problematic since Social Security’s COLA calculation is based on CPI-W readings taken in the third quarter (July through September). If the inflation rate falls significantly, next year’s “increase” will also for the program’s more than 66 million beneficiaries.
Why would US inflation fall in the second half of the year? The dreaded “r” word holds the answer: recession.
During recessions, economic activity slows and unemployment tends to rise. Most importantly, consumers and businesses tend to reduce their spending on goods and services, which weakens demand. At the same time, energy commodities such as oil, which helped drive inflation to a four-decade high of 9.1% in June 2022, are often falling.
Three unmistakable indicators portend an impending recession that will lower COLAs
To be clear, it is not possible to predict in advance when recessions will occur or how long they will last. A number of recession forecasting tools with flawless track records going back more than half a century all agree that a recession is on the way in the US
The best known of these indicators is the Federal Reserve Bank of New York’s Recession Probability Tool. This indicator uses the spread (ie, the difference in yields) between the three-month and the 10-year Treasury bonds to determine how likely a US recession is within the next 12 months. Over the past 56 years, every time the NY Fed’s Recession Probability Tool has exceeded 40%, we have had a recession. It surpassed this mark for December 2022 and hit 57.13% in January 2023.
The ISM Manufacturing New Orders index hit 42.5 in January 2023 before rising slightly last month. US ISM Manufacturing New Orders Index data by YCharts. Gray areas denote recessions.
It is a relatively similar story for the US ISM Manufacturing New Orders Index, which is tasked with measuring new industrial order activity. This index is measured on a scale from 0 to 100, with 50 being the baseline. Any number above 50 signals expansion of industrial orders, while a number below 50 implies contraction.
For about 70 years, every time the US ISM Manufacturing New Orders Index has fallen below 43.5, the US has fallen into recession not long after. It hit 42.5 in January 2023.
The Conference Board Leading Economic Index (LEI) also has a flawless track record of predicting recessions given certain parameters. The LEI, which takes 10 economic inputs into account and is expressed as a six-month annual growth rate, has accurately predicted recessions for the past 64 years. Whenever the LEI falls by more than 4%, a recession has soon followed. LEI in December 2022 was -4.2%.
While it’s possible that the worst of a potential U.S. recession will avoid the three key months when Social Security’s cost-of-living adjustment is calculated, all signs from these foolproof indicators suggest that prices for most goods and services will fall significantly in the not-too-distant future .
In other words, your 2024 Social Security COLA will likely be one long cry from the 8.7% increase enacted this year.