When most Americans retire, Social Security becomes an indispensable source of income. Based on surveys conducted for the past 20 years by national pollster Gallup, between 80% and 90% of retired respondents claim that their Social Security benefit accounts for a "major" or "minor" source of income.
Given the vital 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).
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Social Security's COLA is the program's most-awaited annual announcement
Social Security's COLA is the "raise" beneficiaries receive most years that accounts for the rising price of goods and services, which you probably know better as inflation. The COLA is effectively the mechanism designed to help Social Security's more than 66 million beneficiaries sustain their buying power over time.
Before 1975, inflation-based adjustments to payouts were done at random and had to be approved by special sessions of Congress. Since 1975, COLA has been calculated annually by the program's inflationary tether, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The CPI-W is made up of a large basket of goods and services, each with their own respective percentage weightings. 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 to previous months or the year-ago period to determine if prices have risen (inflation) or declined (deflation) as a whole.
Except for three years since 1975, Social Security's beneficiaries have received a "raise" the following year. And if you were wondering why I've put "raise" in quotation marks, it's to represent that this increase in monthly benefits is designed to keep pace with inflation and isn't akin to a raise that you'd get from an employer that could outpace the prevailing inflation rate.
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Your 2024 Social Security COLA could be a dud
This year, Social Security beneficiaries are enjoying a truly historic COLA. The 8.7% "raise" they've received is the largest on a percentage basis in 41 years. In nominal-dollar terms, the average monthly payout boost of $146/month for retired workers is the biggest 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 this assertion.
The issue at hand is that the U.S. inflation rate is likely to tumble during the second half of 2023. That's problematic, given Social Security's COLA calculation is based on CPI-W readings taken during the third quarter (July through September). If the rate of inflation sinks significantly, so will next year's "raise" for the program's more than 66 million beneficiaries.
Why would the U.S. inflation rate tumble in the second half of the year? The dreaded "r" word holds the answer: recession.
During recessions, economic activity slows, and the unemployment rate tends to rise. Most importantly, consumers and businesses tend to pare back their spending on goods and services, which weakens demand. Concurrently, energy commodities, such as oil, which helped power the inflation rate to a four-decade high of 9.1% in June 2022, often decline.
Three flawless indicators portend an imminent recession that'll lower COLAs
To be perfectly clear, it's not possible to pinpoint ahead of time when recessions will occur or how long they'll last. However, a number of recession-forecasting tools with flawless track records dating back more than a half-century are all in agreement that a recession is forthcoming in the U.S.
The best-known of these indicators is the Federal Reserve Bank of New York's recession probability tool. This indicator uses the spread (i.e., difference in yields) between the three-month and 10-year Treasury bond to determine how likely a U.S. recession is within the next 12 months. Over the past 56 years, every time the NY Fed's recession-probability tool has surpassed 40%, we've 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 rebounding a bit last month. US ISM Manufacturing New Orders Index data by YCharts. Gray zones denote recessions.
It's a relatively similar story for the U.S. ISM Manufacturing New Orders Index, which is tasked with measuring new industrial order activity. This index is measured on a scale of 0 to 100, with 50 being the baseline. Any number above 50 signals industrial order expansion, while a figure below 50 implies contraction.
For roughly 70 years, anytime the U.S. ISM Manufacturing New Orders Index has fallen below 43.5, the U.S. has fallen into a recession not long thereafter. It hit 42.5 in January 2023.
The Conference Board Leading Economic Index (LEI) also sports a flawless track record of predicting recessions when given certain parameters. The LEI, which takes 10 economic inputs into account and is expressed as a six-month annualized growth rate, has been accurately forecasting recessions for the past 64 years. Anytime the LEI declines by more than 4%, a recession has soon followed. The December 2022 LEI was -4.2%.
While it is 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 flawless indicators suggest prices for most goods and services are set to fall considerably in the not-too-distant future.
In other words, your 2024 Social Security COLA is probably going to be a far cry from the 8.7% raise passed along this year.
