KEY DATA: PPI: +0.2%; Goods: -0.4%; Services: +0.5%: Food: +1.0%; Energy: -3.0%/NAHB: up 4 points
IN A NUTSHELL: “While wholesale inflation remains modest, what energy is giving, food is taking away.”
WHAT IT MEANS: The economy is solid, jobs are being created and the unemployment rate is nearly at full employment, so the Fed has to shift its attention to something else if it is to come up with the next rationalization of why it is keeping rates low. Right now, the FOMC seems to be locked into low compensation gains, but there is also the issue of inflation, or its lack thereof, to fall back on. Some members have already expressed that concern. When it comes to current and future consumer costs, wholesale prices seem to be telling a confusing story. The Producer Price Index rose a little more than expected in October. The large drop in energy costs was supposed to cause the index to decline but there were offsetting increases. In particular, food prices continue to rise sharply and over the year, they are up a whopping 6%. In addition, the index presents a variety of services prices, a key differentiation. Since services comprise 63.5% of the index, this break down better mirrors the economy. The category called “final demand trade services”, which looks at retailing and wholesaling, surged. As a result, the services component rose strongly. Excluding energy, wholesale costs have increased by a moderate 2% over the year. That said, the inflation pipeline is not showing any major problems ahead, even when energy is excluded.
On the housing front, home builders are smiling again. The National Association of Home Builders’ Housing Market Index jumped in November. The sales conditions, future sales and traffic components were all up. The only weakness was in the Midwest. It will be interesting to see if the current bad weather changes things.
MARKETS AND FED POLICY IMPLICATIONS: The Fed is suffering from wandering-eye syndrome. First the members were worried about growth and jobs. When those issues dissipated, they started focusing on the unemployment rate. When that blew through their target they started talking about wage inflation. Worker compensation remains muted but even if it starts to move up, there are rumblings that low inflation could become an issue. In other words, if the Fed wants to keep rates low, they will find something out there that would defend their stance. However, inflation is inching upward, even as it remains below its desired level. The rise in producer prices points to a further modest uptick in household costs, but as I have said many times, the pathway from wholesale to consumer prices is hardly straight. Meanwhile, the economy looks really good and the increase in the Homebuilders’ Housing Market Index reinforces the view that conditions are getting even better. Thus, I am sticking to my belief that the Fed will start raising rates this spring. Meanwhile, in the land of make believe, investors may look at the data and say there isn’t enough inflation for the Fed to do anything in the near term and with the economy improving, it is pedal to the metal, or whatever they say.