Tag: CPI

Markets on Edge as Inflation Jitters Spark Volatility

Posted on by slightbourne@noblecapitalmarkets.com

The red hot U.S. economy has financial markets caught between fears of overheating versus overtightening, leading to a tense environment of volatility and angst. U.S. stocks fell sharply on Tuesday, reversing early gains, as investors grew nervous ahead of this week’s critical inflation report that could help shape the Federal Reserve’s policy path.

All eyes are on Wednesday’s March Consumer Price Index (CPI) data, with economists forecasting headline inflation accelerated to 3.4% year-over-year, up from 3.2% in February. The more closely watched core measure excluding food and energy is expected to ease slightly to 3.7% from 3.8%.

The CPI print takes on heightened importance after a slate of robust economic data has traders quickly recalibrating expectations for Fed rate cuts this year. At the start of 2024, markets were pricing in up to 150 basis points of easing as worries about a potential recession peaked. But those easing bets have been dramatically pared back to just around 60 basis points currently.

The shift highlights how perspicacious the “no landing” scenario of stubbornly high inflation forcing the Fed to remain restrictive has become. Traders now only see a 57% chance of at least a 25 basis point cut at the June FOMC meeting, down from 64% just last week.

“Given the strength of the economic data, it’s getting easier and easier to defend the notion that we might be closer to an overheating economy than one nearing recession,” said Dave Grecsek at Aspiriant. “At the moment, three rate cuts this year seems a little demanding.”

Tuesday’s market turmoil underscored this increased skittishness around the inflation trajectory and its policy implications. Major U.S. indices fell, with the Dow Jones Industrial Average dropping 0.38%, the S&P 500 off 0.32%, and the Nasdaq Composite declining 0.17%.

The sell-off was broad-based, impacting many of the high-growth tech leaders that have powered the market’s gains so far in 2024. Megacap growth stocks including Nvidia, Meta Platforms, and Microsoft fell between 0.2% and 2.9%. Financial stocks, among the most rate-sensitive sectors, were the worst performers on the day with the S&P 500 Financials index down 0.8%.

The heightened volatility and economic uncertainty has been particularly punishing for the small and micro-cap segments of the market. These smaller, higher-risk companies tend to underperform during turbulent periods as investor appetite for risk diminishes. The Russell 2000 index of small-cap stocks fell 1.2% on Tuesday and is down over 5% from its highs just two weeks ago.

Cryptocurrency and blockchain-related stocks also got caught up in the downdraft, with Coinbase Global and MicroStrategy dropping sharply as bitcoin prices tumbled. Moderna bucked the bearish trend with a 6.9% surge after positive data for its cancer vaccine developed with Merck.

Geopolitical tensions around Iran’s threat to potentially close the critical Strait of Hormuz shipping lane added another layer of anxiety.

While some might view the market jitters as a buying opportunity, the unease is unlikely to dissipate soon given the Fed uncertainty. Investors will be closely scrutinizing the minutes from the March FOMC meeting due out on Wednesday as well for additional clues on policymakers’ latest thinking.

With inflation proving stickier than expected, the Fed has increasingly pushed back against market pricing for rate cuts this year. Several Fed officials have emphasized that any cuts in 2024 are far from assured if inflation does not moderate substantially. That will keep all eyes laser-focused on each CPI print going forward.

Markets have been whipsawed by conflicting economic signals and rampant volatility as investors try to game the unpredictable path ahead. With high stakes riding on the inflation trajectory and its policy implications, intense swings are likely to persist as markets grapple with this high-wire act between overheating and overtightening.

Elevated Inflation Readings Complicate Fed’s Rate Cut Timeline

Posted on by slightbourne@noblecapitalmarkets.com

The Federal Reserve’s efforts to tame stubbornly high inflation are facing a fresh challenge, as new economic data released on Thursday showed price pressures are proving more persistent than expected. The latest inflation readings are likely to reinforce the central bank’s cautious approach to cutting interest rates and could signal that borrowing costs will need to remain elevated for longer in 2024.

The new inflation report came from the Labor Department’s Producer Price Index (PPI), which measures the prices businesses receive for their goods and services. The PPI climbed 0.6% from January to February, accelerating from the prior month’s 0.3% rise. Even more concerning for the Fed, core producer prices excluding volatile food and energy components rose 0.3% month-over-month, higher than the 0.2% increase forecast by economists.

On an annual basis, core PPI was up 2% compared to a year earlier, matching January’s pace but exceeding expectations. The stubbornly elevated core figures are particularly worrisome as the Fed views core inflation as a better gauge of underlying persistent price trends.

“Given the stickier than expected nature of inflation, it’s going to be very difficult for the Fed to justify a near-term rate reduction,” said Lindsey Piegza, chief economist at Stifel. “Our base case is that the Fed holds off to the second half of the year before initiating a change in policy.”

The hotter-than-anticipated producer inflation data follows a similarly elevated reading for consumer prices earlier this week. The Consumer Price Index showed core consumer inflation rose 3.8% over the past 12 months in February, also surpassing economist projections.

The back-to-back upside inflation surprises underscore the challenges the Fed faces in its efforts to wrestle price growth back down to its 2% target rate after it reached 40-year highs in 2022. Fed Chair Jerome Powell has repeatedly stressed that the central bank wants to see convincing evidence that inflation is moving “sustainably” lower before easing its monetary policy stance.

In the wake of Thursday’s PPI report, market expectations for the timing of a first Fed rate cut this year shifted slightly. The odds of an initial rate reduction happening at the June meeting dipped from 67% to 63% according to pricing in the fed funds futures market. As recently as earlier this year, many investors had anticipated the first cut would come as soon as March.

The Fed is widely expected to leave interest rates unchanged at the current 5.25%-5.5% range when it concludes its next policy meeting on March 22nd. However, officials will also release updated economic projections and interest rate forecasts, and there is a possibility some could scale back expectations for rate cuts in 2024 given the persistent inflation data.

In December, Fed policymakers had penciled in approximately three quarter-point rate reductions by year-end 2024 based on their median forecast. But the latest inflation figures cast doubt on whether that aggressive easing will ultimately materialize.

“This does leave a degree of uncertainty as to when they cut first and what they’ll do on the dot plot,” said Wil Stith, a bond portfolio manager at Wilmington Trust. “Will they leave it at three cuts or will they change that?”

Former Fed official Jim Bullard downplayed the significance of any single month’s inflation reading, but acknowledged the broad trajectory remains difficult for policymakers. “A little bit hot on the PPI today, but one number like this probably wouldn’t affect things dramatically,” he said.

With inflation proving more entrenched than hoped, the Fed appears set to maintain its policy restraint and leave interest rates at restrictive levels until incoming data provides clear and consistent evidence that the central bank’s battle against rising prices is being won. Consumers and businesses alike should prepare for higher borrowing costs to persist in the months ahead.

Inflation Refuses to Cool as Consumer Prices Surge More Than Expected

Posted on by slightbourne@noblecapitalmarkets.com

Hopes for an imminent pause in the Federal Reserve’s interest rate hiking campaign were dashed on Tuesday as new data showed consumer prices rose more than forecast last month. The stubbornly high inflation figures make it likely the central bank will extend its most aggressive policy tightening cycle since the 1980s.

The Consumer Price Index climbed 0.4% from January and 3.2% annually in February, according to the Bureau of Labor Statistics. That exceeded all estimates in a Bloomberg survey of economists who had projected a 0.3% monthly gain and a 3.1% year-over-year increase.

Stripping out volatile food and energy costs, the core CPI accelerated to 0.4% for the month and 3.8% from a year ago, also topping projections. The surprisingly hot readings marked an unwelcome re-acceleration after months of gradually cooling price pressures had buoyed expectations that the Fed may be able to begin cutting rates before year-end.

The data landed like a bucket of cold water on hopes that had been building across financial markets in recent weeks. Investors swiftly repriced their bets, now seeing around a 90% chance that the Fed’s policy committee will raise interest rates by another quarter percentage point at their March 22nd meeting. As recently as Friday, traders had been leaning toward no change in rates next week.

“After taking a step back the last couple of months, it appears inflation regained its footing in February,” said Rubeela Farooqi, chief U.S. economist at High Frequency Economics. “A re-acceleration could mean a longer period of policy restrictiveness is required to bring it down on a sustained basis.”

The biggest driver of February’s price spike was housing, which accounts for over 40% of the CPI calculation. Shelter costs surged 0.4% for the month and are now up a sizable 5.7% versus a year ago. While down from their 2022 peaks, those increases remain far too hot for the Fed’s comfort.

Rents rose 0.5% in February while the owners’ equivalent measure, which tracks costs for homeowners, jumped 0.4%. Both measures are watched closely by policymakers, as housing represents the heaviest weight in the index and tends to be one of the stickier components of inflation.

David Tulk, senior portfolio manager at Allianz Global Investors, said the latest shelter prints mean “the Fed’s path to restoring price stability is going to be a tough one.” He added that debate among central bankers over whether to raise rates by a quarter percentage point or go for a more aggressive half-point move now seems “settled in favor of 25 basis points.”

Energy and gasoline prices also contributed heavily to February’s elevated inflation figures. The energy index rose 2.3% last month, fueled by a 3.8% surge in gas costs. Those pressures could intensify further after recent OPEC production cuts.

Food prices were relatively contained last month, holding steady from January levels. But overall grocery costs are up 10.2% versus a year ago as the battered supply chains and labor shortages stemming from the pandemic continue to reverberate.

While this latest inflation report dealt a significant blow to hopes for an imminent pivot toward easier Fed policy, economists are still forecasting price pressures to ease over the year thanks to cooling pipeline pressures from housing and wages.

However, reaching the Fed’s 2% inflation target is likely to require a measure of demand destruction and labor market softening that could potentially tip the economy into recession. It remains to be seen if central bank policymakers will be able to orchestrate the elusive “soft landing” they have long aimed for.

New Inflation Data Shows Prices Still Rising, Clouding Path for Fed Rate Cuts

Posted on by slightbourne@noblecapitalmarkets.com

The latest inflation data released Tuesday shows consumer prices rose more than expected in January, defying forecasts for a faster slowdown. The Consumer Price Index (CPI) increased 0.3% over December and rose 3.1% over the last year, down slightly from December’s 3.4% pace but above economist predictions.

Core inflation, which excludes volatile food and energy costs, also came in hotter than anticipated at 0.4% month-over-month and 3.9% annually. Shelter prices were a major contributor, with the shelter index climbing 0.6% in January, accounting for over two-thirds of the overall monthly increase. On an annual basis, shelter costs rose 6%.

While used car and energy prices fell, persistent strength in housing and services indicates inflation remains entrenched in the economy. This could complicate the Federal Reserve’s plans to pivot to rate cuts this year after aggressively raising interest rates in 2023 to combat inflation.

Markets are currently pricing in potential Fed rate cuts beginning as early as May, with around five quarter-point decreases projected through end of 2024. However, Tuesday’s inflation data casts doubt on an imminent policy shift. Many Fed officials have signaled a more gradual approach, with only two or three cuts likely this year.

The hotter CPI print pushed stocks sharply lower in early trading, with the Dow Jones Industrial Average falling over 250 points. Meanwhile, Treasury yields surged higher on expectations for sustained Fed tightening.

Inflation-adjusted wages also fell 0.3% month-over-month when factoring in a decline in average workweek hours. While inflation may be peaking, price increases continue to erode household purchasing power.

Shelter costs present a tricky situation for policymakers. Rental and housing inflation tend to lag other price moves, meaning further gains are likely even if overall inflation slows. And shelter carries significant weighting in the Fed’s preferred core PCE index.

While annual PCE inflation has fallen below 4%, the six-month annualized rate remains near the Fed’s 2% target. Tuesday’s data provides a reality check that the battle against inflation is not yet won.

To tame housing inflation, the Fed may have to accept some economic pain in the form of job losses and supply chain stress. So far, the resilience of the labor market and strong consumer demand has kept the economy humming along.

But the cumulative impact of 2023’s aggressive tightening is still working its way through the economy. Eventually, restrictive policy normally triggers a recession as demand falls and unemployment rises.

The Fed is walking a tightrope, trying to curb price increases without severely damaging growth. But persistent inflationary pressures leave little room for a swift policy reversal.

Rate cuts later this year are still possible, but will depend on compelling evidence that core inflation is on a sustainable downward path toward the Fed’s 2% goal. Until shelter and services costs normalize, additional rate hikes can’t be ruled out.

Markets cling to hopes that falling goods prices and easing supply chain strains will open the door for Fed easing. But policymakers remain laser-focused on services inflation, particularly in housing.

Overall, the January inflation data signals the Fed’s inflation fight is far from over. While markets may yearn for rate cuts, persistent price pressures suggest a longer road ahead before policy can substantively turn dovish.

Inflation Rises More Than Expected in December, Keeping Pressure on Fed

Posted on by slightbourne@noblecapitalmarkets.com

Inflation picked up more than anticipated in December, dimming hopes that the Federal Reserve can soon pause its interest rate hiking campaign.

The Consumer Price Index (CPI) rose 0.3% in December compared to the prior month, according to Labor Department data released Thursday. Economists surveyed by Bloomberg had projected a 0.2% monthly gain.

On an annual basis, inflation hit 3.4% in December, accelerating from November’s 3.1% pace and surpassing expectations for 3.2% growth.

The uptick keeps the heat on the Fed to maintain its aggressive monetary tightening push to wrestle inflation back towards its 2% target. Investors were optimistic the central bank could stop hiking rates and even start cutting them in early 2023. But with inflation proving sticky, the Fed now looks poised to keep benchmark rates elevated for longer.

“This print is aligned with our view that disinflation ahead will be gradual with sticky services inflation,” said Ellen Zentner, chief U.S. economist at Morgan Stanley, in a note.

Core Contributes to Inflation’s Persistence

Stripping out volatile food and energy costs, the core CPI increased 0.3% in December, matching November’s rise. Core inflation rose 3.9% on an annual basis, up slightly from November’s 4.0% pace.

The core reading came in above estimates for a 0.2% monthly gain and 3.8% annual increase. The higher-than-expected core inflation indicates that even excluding food and gas, costs remain stubbornly high across many categories of goods and services.

Shelter costs are a major culprit, with rent indexes continuing to climb. The indexes for rent of shelter and owners’ equivalent rent both advanced 0.5% in December, equaling November’s rise.

Owners’ equivalent rent attempts to estimate how much homeowners would pay if they rented their properties. This category accounts for nearly one-third of the overall CPI index and over 40% of core CPI.

With shelter carrying so much weighting, persistent gains here will hinder inflation’s descent. Supply-demand imbalances in the housing market are delaying a moderation in rents.

Used Cars See Relief; Insurance Soars

Gently easing price pressures showed up in the used vehicle market. Used car and truck prices edged up just 0.1% in December following several months of declines. In November, used auto prices fell 0.2%.

New vehicle prices also cooled again, dipping 0.1% versus November’s 0.2% decrease. The reprieve comes after a long bout of supply shortages weighed on auto affordability.

But motor vehicle insurance blindsided with its largest annual increase since 1976, vaulting 20.3% higher over the last 12 months. In November, the insurance index had risen 8.7% year-over-year.

Food Index Fluctuates

Food prices have been especially volatile, reacting to supply chain disruptions and geopolitical developments like the war in Ukraine. The food index rose 0.1% in December, down from November’s 0.5% increase.

The index for food at home slid 0.1% last month, reversing course after four straight monthly gains. Egg prices spiked 8.9% higher in December, building on November’s 2.2% surge. The egg index has skyrocketed 60% year-over-year.

But not all grocery aisles saw rising costs. Fruits and vegetables turned cheaper, with the index dropping 0.6% as supply conditions improved.

Bigger Picture View

The faster-than-expected inflation in December keeps the Fed on course to drive rates higher for longer to manage price pressures. Markets are still betting officials will engineer a soft landing and start cutting interest rates by March.

But economists warn more patience is needed before declaring victory over inflation. “Overall, the December CPI report reminds us that inflation will decline on a bumpy road, not a smooth one,” said Jeffrey Roach, chief economist at LPL Financial.

Until clear, convincing signs of disinflation emerge, the Fed looks unlikely to pivot from its aggressive inflation-fighting stance. The CPI report illustrates the complexity of the inflation picture, with some components moderating while others heat up.

With shelter costs up over 6% annually and services inflation staying elevated, the Fed has reasons for caution. Moderately higher inflation won’t necessarily prompt more supersized rate hikes, but it may prolong the current restrictive policy.

Investors longing for a Fed “pivot” may need to wait a bit longer. But the war against inflation rages on, even with the December CPI report threatening to squash hopes of an imminent policy easing.

Consumer Confidence Jumps to Five-Month High, Signaling Economic Optimism

Posted on by slightbourne@noblecapitalmarkets.com

U.S. consumer confidence increased substantially in December to reach its highest level in five months, according to new data from the Conference Board. The confidence index now stands at 110.7, up sharply from 101.0 in November. This surge in optimism indicates consumers have a brighter economic outlook heading into 2024.

The gains in confidence were broad-based, occurring across all age groups and household income levels. In particular, confidence rose sharply among 35-54 year olds as well as those earning $125,000 per year or more. Consumers grew more upbeat about both current conditions and their short-term expectations for business, jobs, and income growth.

The large improvement in consumer spirits is likely the result of several positive economic developments in recent months. Stock markets have rebounded, mortgage rates have retreated from their peaks, and gas prices have declined significantly. Many shoppers also appear to be returning to more normal holiday spending after two years of pandemic-distorted patterns.

Labor Market Resilience Boosts Spending Power

Driving much of this economic optimism is the continued resilience in the labor market. The survey’s measure of jobs plentiful versus hard to get widened substantially in December. This correlates with the 3.7% unemployment rate, which remains near a 50-year low. Robust hiring conditions and rising wages are supporting the consumer spending that makes up 70% of GDP.

With inflationary pressures also showing signs of cooling from 40-year highs, households have more spending power heading into 2023. Consumers indicated plans to increase purchases of vehicles, major appliances, and vacations over the next six months. This points to solid ongoing support for economic growth.

Fed Rate Hikes Could Be Nearing an End

Another factor buoying consumer sentiment is growing expectations that the Fed may pause its rapid interest rate hikes soon. After a cumulative 4.25 percentage points of tightening already delivered, markets are betting on a peak rate below 5% in early 2024.

This prospect of nearing an end to historically-aggressive Fed policy has sparked a powerful rally in rate-sensitive assets like bonds and stocks while boosting housing affordability. With inflation expectations among consumers also falling to the lowest since October 2020, pressure on the central bank to maintain its torrid tightening pace is declining.

Housing Market Poised for Rebound

One key area that could see a revival from lower rates is the housing sector. Existing home sales managed to eke out a small 0.8% gain in November following five straight months of declines. While higher mortgage rates earlier this year crushed housing affordability, the recent rate relief triggered a jump in homebuyer demand.

More consumers reported plans to purchase a home over the next six months than any time since August. However, extremely tight inventory continues hampering sales. There were just 1.13 million homes for sale last month, 60% below pre-pandemic levels. This lack of supply will likely drive further home price appreciation into 2024.

The median existing-home price rose 4% from last year to $387,600 in November. But lower mortgage rates could bring more sellers and buyers to the market. Citigroup economists project stronger price growth next spring and summer as rates have room to decrease further. This would provide a boost to household wealth and consumer spending power.

Economic Growth Appears Solid Entering 2024

Overall, with consumers opening their wallets and the job market thriving, most economists expect the US to avoid a downturn next year. The sharp rise in confidence, spending intentions, and housing market activity all point to continued economic growth in early 2024.

Inflation and Fed policy remain wildcards. But the latest data indicates the price surge has passed its peak. If this trend continues alongside avoiding a spike in unemployment, consumers look primed to keep leading GDP forward. Their renewed optimism signals economic momentum instead of approaching recession as 2024 gets underway.

From Inflation to Deflation: A Seasonal Shift in Consumer Prices

Posted on by slightbourne@noblecapitalmarkets.com

Consumers tapped out from inflation may finally get a reprieve this holiday season in the form of falling prices. According to Walmart CEO Doug McMillon, deflation could be on the horizon.

On a Thursday earnings call, McMillon said the retail giant expects to see deflationary trends emerge in the coming weeks and months. He pointed to general merchandise and key grocery items like eggs, chicken, and seafood that have already seen notable price decreases.

McMillon added that even stubbornly high prices for pantry staples are expected to start dropping soon. “In the U.S., we may be managing through a period of deflation in the months to come,” he said, welcoming the change as a benefit to financially strapped customers.

His comments echo optimism from other major retailers that inflation may have peaked. Earlier this week, Home Depot CFO Richard McPhail remarked that “the worst of the inflationary environment is behind us.”

Government data also hints the pricing pressures are easing. The consumer price index (CPI) for October was flat compared to September on a seasonally adjusted basis. Core CPI, which excludes volatile food and energy costs, dipped to a two-year low.

This emerging deflationary environment is a reprieve after over a year of runaway inflation that drove the cost of living to 40-year highs. Everything from groceries to household utilities saw dramatic price hikes that squeezed family budgets.

But the October CPI readings suggest the Federal Reserve’s aggressive interest rate hikes are having the desired effect of reining in excessive inflation. As supply chains normalize and consumer demand cools, prices are softening across many categories.

For instance, the American Farm Bureau Federation calculates that the average cost of a classic Thanksgiving dinner for 10 will be $64.05 this year – down 4.5% from 2022’s record high of $67.01. The drop is attributed largely to a decrease in turkey prices.

Still, consumers aren’t out of the woods yet when it comes to stubborn inflation on essentials. While prices are down from their peak, they remain elevated compared to historical norms.

Grocery prices at Walmart are up mid-single digits versus 2022, though up high-teens compared to 2019. Many other household basics like rent, medical care, and vehicle insurance continue to rise at above average rates.

And American shopping habits reflect the impact of lingering inflation. Walmart CFO John David Rainey noted consumers have waited for discounts before purchasing goods such as Black Friday deals.

McMillon indicated shoppers are still monitoring spending carefully. So while deflationary pressure is a tailwind, Walmart doesn’t expect an abrupt return to pre-pandemic spending patterns.

The retailer hopes to see food prices in particular come down faster, as grocery inflation eats up a significant chunk of household budgets. But experts warn it could take the rest of 2023 before inflation fully normalizes.

Consumers have been resilient yet cautious under economic uncertainty. If deflation takes root across the retail landscape, it could provide much-needed relief to wallets and mark a turning point toward recovery. For now, the environment looks favorable for a little more jingle in shoppers’ pockets this holiday season.

Inflation Pressures Continue to Ease in October

Posted on by slightbourne@noblecapitalmarkets.com

The latest Consumer Price Index (CPI) report released Tuesday morning showed inflation pressures continued to ease in October. Consumer prices were unchanged for the month and rose 3.2% over the last 12 months. This marks a deceleration from September’s 0.4% monthly increase and 3.7% annual inflation rate.

Core inflation, which excludes volatile food and energy costs, also showed signs of moderating. The core CPI rose 0.2% in October, down from 0.3% in September. On an annual basis, core inflation was 4.0% in October, slower than the 4.1% pace in September and the lowest since September 2021.

Falling Energy Prices Hold Down Headline Inflation

Much of the monthly easing in prices was due to falling energy costs. Energy prices dropped 2.5% in October, driven largely by a 5% decline in gas prices during the month. This helped offset increases in other areas and kept headline CPI flat for October. Lower oil and gas prices also contributed to the slowing in annual inflation.

The recent drop in gas prices is welcome news for consumers who saw prices spike earlier this year. According to AAA, the national average for a gallon of regular gasoline has fallen to $3.77 as of Nov. 14, down from a record high of $5.02 in mid-June. If prices continue to trend lower, it would provide further relief on overall inflation.

Shelter Inflation Moderates

The shelter index, which includes rents and homeowner costs, has been a major driver of inflation this year. But there are signs of moderation taking hold. Shelter inflation rose 6.7% over the last year in October, the smallest increase in 12 months. On a monthly basis, shelter costs were up just 0.3% in October versus 0.6% in September.

Rents are a key component of shelter inflation. Growth in rents indexes slowed in October, likely reflecting a cooling housing market. The index for rent of primary residence increased 0.5% for the month, while the owners’ equivalent rent index rose 0.4%.

Used Vehicle Prices Extend Declines

Consumers also got a break on used vehicle prices in October. Prices for used cars and trucks fell 0.8% in October, after a 2.5% decline in September. New vehicle prices dipped 0.1% as auto supply constraints slowly ease.

Used car prices skyrocketed in 2021 and early 2022 amid low inventories. But prices have now fallen 7.5% from the record high set in May 2022, helping reduce inflationary pressures.

Outlook for Fed Policy

Financial markets took the CPI report as another sign the Federal Reserve is getting inflation under control. Markets are now pricing in a near 100% chance the Fed holds rates steady at its December policy meeting. This follows four consecutive 0.75 percentage point hikes between June and November.

Fed Chair Jerome Powell recently indicated the central bank can slow the pace of hikes as inflation moves back toward the 2% target. But he cautioned there is still “some ways to go” in bringing inflation down.

Most economists expect the Fed to continue holding rates in the first half of 2023. But sticky inflation in services may mean rates have to stay elevated for longer before the Fed can contemplate rate cuts. Wage growth and the tight labor market also pose upside risks on inflation.

For consumers, easing inflation provides some financial relief after two difficult years. But prices remain substantially above pre-pandemic levels. Moderating inflation is a positive sign the Fed’s policies are working, but households will likely continue feeling price pressures for some time.

Surprisingly Strong September Retail Sales Raises Hopes for Soft Landing

Posted on by slightbourne@noblecapitalmarkets.com

U.S. retail sales rose an unexpectedly robust 0.7% in September, surpassing economist forecasts of a flat or negative number. The solid spending data provides a dose of optimism that the economy can achieve a soft landing amidst high inflation and aggressive Fed rate hikes.

September’s gains were broad-based across categories like autos, gasoline, furniture, clothing, hobbies, and food services. The growth comes even as inflation persists at elevated levels, with the September Consumer Price Index report showing prices climbed 8.2% year-over-year.

However, the 0.4% monthly CPI increase was smaller than anticipated. This potentially indicates inflationary pressures are beginning to gradually ease.

Markets rallied on the retail sales beat, interpreting it as a sign of consumer resilience despite inflation chipping away at budgets. Stocks rose on hopes a soft landing—where the Fed engineers an economic cooldown without triggering a recession—appears more plausible.

Retail spending has seesawed in recent months, decreasing 0.4% in August as high prices at the pump drained consumer budgets. But gas prices have since moderated, alleviating some of this pressure. This freed up disposable income in September, evidenced by solid auto sales and increases in discretionary categories.

The better-than-expected data implies consumers still have some power to prop up the economy, though inflation remains a challenge. Prices dipped from the previous month’s 8.3% annual increase but continue running severely above the Fed’s 2% target. This explains why the central bank is almost certain to enact another large interest rate hike in early November.

Fed officials assert they will continue raising rates aggressively until inflation is convincingly tamed. This risks going too far and sparking a recession. But if inflation keeps gradually trending downwards, it raises confidence the Fed can stick the landing.

Firms are bracing for a potential downturn, with many announcing hiring freezes and cost cuts. However, the job market has yet to take a significant hit, which would severely impair consumer spending power. As long as individuals keep spending reasonably well, it makes a soft landing more feasible.

Looking ahead, the path for retail sales and inflation remains highly uncertain. More data will be required to determine if September’s retail boost was an anomaly or the start of more sustainable momentum. Inflation similarly needs to keep dropping before proclaiming victory.

But for now, September’s numbers provide a dose of positivity that the economy is not yet on the brink of cratering into recession. Consumers are weathering the inflation storm better than feared, aided by falling gas prices and healthy job gains.

This means the Fed can continue ratcheting up interest rates with less risk of immediately crashing growth. However, policymakers are unlikely to declare mission accomplished and halt hikes anytime soon.

For the soft landing narrative to play out, retail strength and inflation moderation will need to persist over coming months. September offered promising signs, but more evidence is required to confidently say a harsh recession is avoidable. The Fed will be monitoring data closely to ensure its forceful actions steer the economy in the right direction.

Rising Housing Costs Drive Consumer Inflation Even Higher in September

Posted on by slightbourne@noblecapitalmarkets.com

Consumer inflation accelerated more than expected in September due largely to intensifying shelter costs, putting further pressure on household budgets and keeping the Federal Reserve on high alert.

The consumer price index (CPI) increased 0.4% last month after rising 0.1% in August, the Labor Department reported Thursday. On an annual basis, prices were up 3.7% through September.

Both the monthly and yearly inflation rates exceeded economist forecasts of 0.3% and 3.6% respectively.

The higher than anticipated inflation extends the squeeze on consumers in the form of elevated prices for essentials like food, housing, and transportation. It also keeps the Fed under the microscope as officials debate further interest rate hikes to cool demand and restrain prices.

Source: U.S. Bureau of Labor Statistics

Surging Shelter Costs in Focus

The main driver behind the inflation uptick in September was shelter costs. The shelter index, which includes rent and owners’ equivalent rent, jumped 0.6% for the month. Shelter costs also posted the largest yearly gain at 7.2%.

On a monthly basis, shelter accounted for over half of the total increase in CPI. Surging rents and housing costs reflect pandemic trends like strong demand amid limited supply.

“Just because the rate of inflation is stable for now doesn’t mean its weight isn’t increasing every month on family budgets,” noted Robert Frick, corporate economist at Navy Federal Credit Union. “That shelter and food costs rose particularly is especially painful.”

Energy and Food Costs Also Climb

While shelter led the inflation surge, other categories saw notable increases as well in September. Energy costs rose 1.5% led by gasoline, fuel oil, and natural gas. Food prices gained 0.2% for the third consecutive month, with a 6% jump in food away from home.

On an annual basis, energy costs were down 0.5% but food was up 3.7% year-over-year through September.

Used vehicle prices declined 2.5% in September but new vehicle costs rose 0.3%. Overall, transportation services inflation eased to 0.9% annually in September from 9.5% in August.

Wage Growth Lags Inflation

Rising consumer costs continue to outpace income growth, squeezing household budgets. Average hourly earnings rose just 0.2% in September, not enough to keep pace with the 0.4% inflation rate.

That caused real average hourly earnings to fall 0.2% last month. On a yearly basis, real wages were up only 0.5% through September—a fraction of the 3.7% inflation rate over that period.

American consumers have relied more heavily on savings and credit to maintain spending amid high inflation. But rising borrowing costs could limit their ability to sustain that trend.

Fed Still Focused on Inflation Fight

The hotter-than-expected CPI print keeps the Fed anchored on inflation worries. Though annual inflation has eased from over 9% in June, the 3.7% rate remains well above the Fed’s 2% target.

Officials raised interest rates by 75 basis points in both September and November, pushing the federal funds rate to a range of 3-3.25%. Markets expect another 50-75 basis point hike in December.

Treasury yields surged following the CPI report, reflecting ongoing inflation concerns. Persistently high shelter and food inflation could spur the Fed to stick to its aggressive rate hike path into 2023.

Taming inflation remains the Fed’s number one priority, even at the risk of slowing economic growth. The latest CPI data shows they still have work to do on that front.

All eyes will now turn to the October and November inflation reports heading into the pivotal December policy meeting. Further hotter-than-expected readings could force the Fed’s hand on more supersized rate hikes aimed at cooling demand and prices across the economy.

Consumer Prices Rise at Faster Pace in August

Posted on by slightbourne@noblecapitalmarkets.com

The Consumer Price Index (CPI) increased 0.6% in August on a seasonally adjusted basis, quickening from the 0.2% rise seen in July, according to the Bureau of Labor Statistics’ latest report. Over the past 12 months through August, headline CPI inflation stands at 3.7% before seasonal adjustment, up from 3.2% for the 12-month period ending in July.

The August monthly gain was primarily driven by a spike of 10.6% in the gasoline index. Gasoline was coming off a tamer 0.2% increase in July. Food prices also contributed to inflationary pressures, with the food at home index edging up 0.2% again last month. The food away from home index rose 0.3%.

Meanwhile, the energy index excluding gasoline picked up as well. Natural gas costs ticked up 0.1%, electricity prices rose 0.2%, and fuel oil prices surged 9.1%.

The core CPI, which removes volatile food and energy categories, rose 0.3% in August after a 0.2% gain in July. The shelter index has been a main driver of core inflation. It covers rental costs and owners’ equivalent rent, both of which have rapidly increased due to imbalances between housing supply and demand.

On an annual basis, the energy index has fallen 3.6%, as gasoline, natural gas and fuel oil costs are down over the past 12 months. However, the food and core indexes are up 4.3% and 4.3% year-over-year, respectively.

Within the core CPI, the main drivers have been shelter costs, up 7.3% over the last 12 months, along with auto insurance (+19.1%), recreation services (+3.5%), personal care (+5.8%) and new vehicles (+2.9%). Medical care services inflation has also accelerated to 6.6% over the past year.

Geographically, inflation varies significantly by region. The Northeast has seen 4.2% CPI inflation over the past year, the Midwest 3.9%, the South 3.7%, and the West just 2.9%. By city size, larger metropolitan areas over 1.5 million people have experienced 3.8% inflation, compared to 3.6% for mid-sized cities and 3.7% in smaller cities.

August’s monthly data shows inflation quickened after signs of cooling in July. While gasoline futures retreated in September, shelter inflation remains stubbornly high with no meaningful relief expected until mortgage rates decline substantially.

With core inflation running well above the Fed’s 2% target, further interest rate hikes are anticipated to combat still-high inflation. But the path to a soft economic landing appears increasingly narrow amid recession risks.

The next CPI update will be released in mid-October, shedding light on whether persistent pricing pressures are continuing to squeeze household budgets. For now, the August report shows inflation picking up steam after the prior month’s encouraging data.

Looking Ahead

Consumers may get temporary relief in the near term at the gas pump, as oil and gasoline futures prices pulled back in September following OPEC’s modest production cut.

Yet the larger concern remains the entrenched inflation in essentials like food, rent and medical care. Shelter inflation in particular has shown little sign of abating, as rental rates and housing prices remain disconnected from incomes.

Mortgage rates have soared above 6% in 2023 after starting the year around 3%. The sharp rise in financing costs continues to shut many homebuyers out of the market. Until mortgage rates meaningfully decline, shelter inflation is likely to persist.

And that will be challenging as long as the Fed keeps interest rates elevated. Monetary policy has lagged in responding to inflation, putting central bankers in catch-up mode. Further rate hikes are expected in the coming months absent a significant cooling in pricing pressures.

But the risks of the Fed overtightening and spurring a recession continue to intensify. The path to a soft landing for the economy is looking increasingly precarious.

For consumers, it means further inflationary pain is likely in store before a sustained moderation emerges. Budgets will remain pressured by pricier essentials, leaving less room for discretionary purchases.

While the monthly data will remain volatile, the overall trend points to stubborn inflation persisting through year-end. The Fed will be closely watching to see if their actions to date have slowed price gains enough. If not, consumers should prepare for more rate hikes and resulting economic uncertainty into 2024.

PCE Inflation Versus CPI Inflation, What’s the Difference?

Posted on by phoffman@channelchek.com
Image Credit: Brenda Gottsabend (Flickr)

The Increasing Popularity of the PCE Inflation Gauge

US inflation, by a number of official measures, reached its highest level in 40 years last year. For a large percentage of investors and shoppers, this is their first experience of prices quickly rising. For decades, on many tech products, prices declined over time (while adding functionality). There are a number of different measures of inflation reported regularly – they impact us in different ways. Knowing the difference, whether you’re investing, planning a purchase, or expecting a cost of living (COLA) increase, is helpful. Below we go through the different measures so you understand the impact of say “headline CPI” versus “core PCE.”

According to James Bullard, the president and CEO of the Federal Reserve Bank of St. Louis,  “measuring inflation is one of the most difficult issues studied by economists.”

By definition, inflation is the percentage change in overall prices in the economy over a specified period, commonly quoted as a year-over-year change. It’s much more than an increase in the prices of a few products. Given the inherent difficulties in following every price in the country, economists have created price indexes to approximate the overall price level.

PCE Inflation

Before the year 2000, the Federal Open Market Committee (FOMC) primarily focused on the Consumer Price Index (CPI) as its inflation gauge. We’ll explain CPI next, but for the Fed, when it now says it has a 2% inflation target, PCE is the data used.

Though the two indexes have a lot of overlap, there are reasons why the PCE is considered a better tool by policymakers.

The PCE price index, which rose 5.5% in November 2022 from a year earlier, is derived from a broader index of prices than the CPI’s more narrow set of goods and services. The argument as to why policymakers gave an edge in the late 1990s to make the change in 2000 is that a more comprehensive index (such as PCE) of prices provides a better way to gauge underlying inflationary pressures. Since the PCE includes more goods and services, the index’s weights for particular items will differ dramatically from those in the CPI. For example, housing has a weight of about 16% in the PCE price index versus 33% in the CPI. The varied items more accurately reflect actual costs to consumers since they may substitute one for another as prices of items change at different rates. This ability to substitute is a primary reason why PCE tends to print lower than headline CPI.

CPI Remains Important

The most widely cited measure of inflation is the headline Consumer Price Index (CPI), which is calculated by the Bureau of Labor Statistics (BLS). This index was created in 1919 as officials devised a way to measure rising consumer prices just after World War I.

The CPI, which rose 6.5% for all of 2022, measures the price changes for a basket of goods and services purchased by the typical urban consumer. The items in this basket are weighted by their relative importance in consumer expenditures. For example, housing—rent and other spending on shelter—accounts for 33% of the index, while medical care accounts for nearly 9%.

This index, like others, takes into account changing consumption. New items come in and old items leave. The example I like to use is that prohibition began in January 1920, just after CPI came into use. Alcohol was not part of the index back then, whereas it is today (5.78% increase in 2022), product adoption changes.

The CPI weights had been adjusted every two years using two years of consumer spending data. Starting in 2023, the BLS will update weights annually using one year of data.

Headline PCE Inflation versus Headline CPI Inflation

The increasing popularity of the PCE is because the index’s weights are updated monthly, versus annually for CPI (prior to 2023 updates were every two years). Thus, the PCE can quickly reflect the impact of new technology or an abrupt change in consumer spending patterns. For example, the onset of the coronavirus pandemic quickly shifted consumption from services like restaurants to services like communication technology. Since the headline PCE uses more timely, actual outlays, it provides the FOMC a more accurate consumer experience in terms of inflation.  

The stated target by the FOMC is 2%, a level that policymakers judge to be consistent with achieving price stability and maximum employment. On average, inflation was hovering below this target before the pandemic’s economic ramifications (from 1995 through 2019 PCE average equaled 1.8%).  

Other Inflation Measures

While the FOMC targets headline PCE inflation, policymakers also watch other measures to gauge inflationary pressures. The headline PCE measure can be quite volatile due to the effects of extreme price movements for certain products. To get a sense of where underlying inflation really is, economists often look at some summary measure of inflation that doesn’t include these volatile prices.

A so-called “core” index—whether it be PCE or CPI—excludes food and energy components. That has some simplicity around it, but it’s not satisfactory. There are better ways to analyze underlying inflation than to throw out certain goods and services, especially those that hit low- to moderate-income consumers the hardest when prices rise. And even if you exclude food and energy prices, the remaining part of the index is still affected by their volatility; restaurant prices would be a classic example.

More recently, other statistical ideas have been developed. One method looks at price change distribution for the entire range of goods and services.3

One commonly used measure of this type is the Dallas Fed trimmed-mean PCE inflation rate, which removes the upper tail (the largest price changes) and the lower tail (the smallest price changes) and then takes a weighted average of the price changes for the remaining components. This measure has been popular as a tool for examining trends and overall inflation as opposed to special factors that might be driving inflation. Of course, these types of measures4 tend to be more persistent and move more slowly than headline inflation measures.

Take Away

While market concerns over inflation for many years were low and most may have been more concerned about deflation, the current tight supply of goods and labor, coupled with the easiness of money, has ushered in a period where markets are likely to feel the impact of each inflation post.

Understanding the most watched inflation gauges will help sort out whether a trend or single post is likely to cause a change in course on interest rates. Or is it more likely a blip that will on average work its way out? The Fed is currently targeting a PCE inflation rate of 2%. The current pace is more than double this, but trending down after the Fed tightened in 2022 at a record pace. The Fed and the markets are now awaiting the impact of those cuts as there is a lag in applying the economic brakes (to lessen inflation) and when the economy has its biggest reaction to the Fed’s heavy pressure on the brake pedal.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/speech/powell20200827a.htm

https://files.stlouisfed.org/files/htdocs/publications/review/11/07/bullard.pdf

https://www.usinflationcalculator.com/

https://ycharts.com/indicators/us_consumer_price_index_alcoholic_beverages_unadjusted

https://www.stlouisfed.org/publications/regional-economist/2022/sep/making-sense-inflation-measures#authorbox