December Consumer Prices and Real Earnings

KEY DATA: CPI: -0.1%; Excluding Energy: +0.2%; Gasoline: -7.4%/ Inflation-Adjusted Hourly Earnings: +0.5%; Over Year: 1.1%

IN A NUTSHELL:  “Inflation continues at a pace that should make the Fed happy, but accelerating wage gains remain a threat.”

WHAT IT MEANS:  While parts of the government’s data mill are shut down, the Bureau of Labor Statistics keeps churning some key numbers.  Consumer Prices declined in December, led, not surprisingly by a sharp drop in energy costs.  Excluding energy, consumer costs rose at a moderate pace.  Over the year, the core index, which excludes food and energy, increased at a 2.2% rate, slightly above the Fed’s 2% target.  Looking at the non-energy components, inflation pressures are building in a number of areas.  Food costs, which had jumped in 2017 but stabilized last year, look like they could be back on the rise.  The drive to eat healthier is becoming much more expensive as fish and seafood costs are jumping.  My biggest concern is that my bellowed cake and cupcake prices are skyrocketing.  Time to diet again.  Eating out is also becoming much more expensive, as is the cost of shelter.  And the flattening in medical costs may be coming to an end.  So, while consumer inflation is not accelerating significantly, there seem to be underlying trends that indicate we could see the rate rise as we go forward.

The tight labor market continues to push up wages, which rose sharply in December.  They jumped by over 3% from the December 2017 level.  With overall consumer costs declining, inflation-adjusted (real) earnings improved quite solidly.  Over the year, they broke back over the 1% level for the first time in over two years.  Since energy prices are rebounding, that may not hold.  Still, when spending power is rising by only 1% and with the savings rate trending downward, it is hard to see how spending can hold up. 

MARKETS AND FED POLICY IMPLICATIONS:  Chairman Powell baffles me.  He talks about the economy as if it is in good shape, but then indicates that continuing the rate normalization process may or may not continue.  Growth is still good and inflation is at or above the Fed’s target.  So, what is his problem?  You can say that the sharp drop in the equity markets is a sign of impending doom, or you can argue as I have that the decline simply corrects for some irrational exuberance.  If the markets are signaling a recession ahead, then slowing or ending the normalization process makes sense.  If the volatility was more emotional as well as a normal correction from excessively optimistic expectations, then it doesn’t make sense to slow the rate hikes.  Since the Fed’s own estimates are for at about 2.3% growth this year, which is above the members’ estimate of trend growth, what is the problem?  As I said, I just don’t get it.  The next FOMC meeting where a hike might occur is not until March 19-20.   Unless the government shut down and the trade war seriously harm growth, I don’t see why an increase shouldn’t happen at that meeting, if the Fed really is basing its decisions on economic data.