KEY DATA: PPI: -0.1%; Goods: 0%; Services: -0.2%/ Claims+11,000
IN A NUTSHELL: “Falling food and trade costs are helping keep producer expenses under control.”
WHAT IT MEANS: With the 10-year Treasury note approaching levels rarely seen in the past 3½ years, questions are being raised about how high it will go over the next year. Implementing expansionary fiscal policy when the economy is growing decently and the labor market is tight is a risky experiment, as it raises the risk that inflation could accelerate faster than expected. But those effects are not likely to be seen right away since it could take months before the tax cuts make much of a difference in consumption. It actually has to show up in paychecks and then be spent. Until that happens, we have to watch leading indicators of consumer prices and the Producer Price Index is one of them.
Wholesale costs fell in December, led by a sharp decline in food prices. I am not sure what is going, but the drop was broad based as thirteen of the twenty food sectors posted declines. I expect that drop will be reversed pretty quickly. Energy costs were flat and we know that oil prices have surged lately. On the services side, trade costs cratered. I suspect that the decline was overdone, but wholesale and retail services are likely to remain well contained for a long time. However, transport costs are likely to keep surging. Basically, this report, while looking tame for now, could look a lot different next month. And going forward, don’t be surprised if producer prices keep trending upward as intermediate prices are rising more strongly than finished goods and services prices. There are cost pressures building in the pipeline.
New claims for unemployment insurance jumped last week and the trend is slightly upward. That is strange given all the other data on layoffs. In addition, the number of claims was up compared to last year. They had been down over the year for about eight years. It is too soon to say a trend is developing, but it is worth watching.
MARKETS AND FED POLICY IMPLICATIONS: Energy costs are rising, but there doesn’t appear to be any major, widespread acceleration in producer prices. Indeed, the tax breaks should provide an earnings cushion so businesses have the capacity to limit price increases even if expenses rise. Thus, it is hard to see that inflation will soar anytime soon. But pressures are building and stronger growth will only exacerbate the problem. I do think that consumer inflation will hit the Fed’s 2% target by mid-year and start consistently exceeding it during the second half of the year. But until that happens, the Fed has some room to allow prices to rise. As for investors, any excuse to keep the rally going will be used and now that we are in earnings season, there may be lots of reasons for equities to do well. I expect that fourth quarter earnings were strong.