KEY DATA: CPI: -0.4%; Excluding Energy: 0%; Food: +0.3%/ Real Earnings: +0.1%/ IP: -0.1%; Manufacturing: +0.3%
IN A NUTSHELL: “Falling prices may worry some but households are ecstatic and manufacturers are gearing up to meet the growing demand.”
WHAT IT MEANS: Horrors of horrors, energy prices are falling. If you watch the business news, that is what you would think. With another sharp drop in gasoline, the Consumer Price Index posted its largest decline in six years. So, should we worry? Not really. Excluding energy, prices were flat and over the year, non-energy costs were up nearly 2%. That is not deflation. The December report was really odd. There were a large number of components that posted outsized changes. Apparel and used vehicle prices fell by over 1% while medical goods and energy services rose 1%. Just about every major category was either up or down by 0.2% or more and that is not a normal pattern. As for deflation, don’t tell that to people who have to spend a lot of their money on food and utilities. Those costs were up solidly. My suggestion: Stop looking at the headline number because when oil turns around, and it just might be starting to do that, the sign will simply change even if the magnitude doesn’t.
Real earnings rose modestly in December and that is distressing. When prices fall sharply, if all you can get is a small rise in spending power, there are real problems out there. This economy would be a lot better off with a little more money going to workers.
It will take additional quarters of strong growth to get to the point in the labor market where businesses will have to start raising wages faster and that growth is likely to occur. Industrial production fell in December but a warm December (hoorah!) caused utility output to tank. Meanwhile, manufacturing production rose solidly once again, despite a small pull back in vehicle assembly rates. The University of Michigan’s mid-month reading of consumer sentiment rose to its highest level in eleven years. It’s almost as if happy days are here again. The lower gas prices are going to wind up in the economy and better wage gains could trigger robust consumption.
MARKETS AND FED POLICY IMPLICATIONS: The economy is growing solidly and households are a happy bunch of campers once again, so it looks like 2015 should be a really good year. Strong growth, coupled with oil price stability or even increases, will make people forget the idea of deflation and turn to the more important issue: When will the dam that is holding back wage gains break? Normally, labor shortages lead to rising wages, which begin slowly once the inability to find workers starts appearing. That is not happening this time. Instead, we are creating the next “bubble”, which is the pent-up demand for higher wages. The longer we go without slowly raising wages, the greater the surge will be. The Fed may think it has time because labor compensation growth is largely non-existent. But if my view is correct, when the capitulation occurs, wages will jump, catching the Fed with its rates down.