January Wholesale Prices, Small Business Optimism and Fed Chair Yellen’s Comments

KEY DATA: PPI: +0.6%; Goods: +1%; Services: +0.3%; Ex-Food and Energy: +0.2%/ NFIB: +0.1 point

IN A NUTSHELL: “With top line inflation driving the Fed’s decision, any increase in costs moves the FOMC closer to its next rate hike.”

WHAT IT MEANS: The Fed intends to raise rates this year and more than likely several times. That much was made clear by Chair Yellen, who commented thatWaiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession“. She also noted that the Fed looks at top line inflation, which they are confident is moving toward its 2% target and that the unemployment rate is already at the level members believe is full employment. In other words, the Fed is ready to go and the only thing stopping it is below-target inflation. That is why the sharp rise in the January Producer Price Index is important. Much of the increase came from another jump in energy costs, but it wasn’t limited to petroleum. Services prices bounced back and the only thing keeping the index from rising faster were flat food costs. There is also some pressure building in the pipeline.

The National Federation of Independent Businesses reported that small business confidence edged up in January, solidifying the gains made since the election. Firms have a large number of job openings and hopefully they will be able to fill them. Owners seem willing to invest, even though the index eased a touch in January, it remains at a high level.

MARKETS AND FED POLICY IMPLICATIONS: There are great expectations that the president and Congress will come through with tax cuts and regulatory changes that will “unleash the beast” in the corporate sector. But that has to happen and lines are being drawn in the sand – and not just by Democrats. A Republican member of the House Ways and Means Committee said that there would be no tax reform without a border adjustment tax, which subsidizes exports and penalizes those that import. He is basically arguing it is time to move to a consumption tax structure. That would create a large number of winners and losers and consumers could see higher prices. Indeed, a border tax, previously known as a tariff, might be necessary as well to offset the revenue losses of tax reform. So, let the battles begin and one of the groups who may be involved is the Fed. Higher consumer costs and aggressive fiscal policy will be the green light to move rates back up to more normal levels. And the Chair noted that currently, the estimate of a “normal” rate is low because of a number of factors. If those conditions change with stronger growth, the Fed would be chasing an upward moving target. Change isn’t simple and if it is going to happen, the many moving parts have to be considered. But too many in Congress don’t have a clue that there are consequences to making the changes they are proposing. The next year should be lots of fun, with tax reform, regulatory changes, Dodd-Frank, Obamacare and rate hikes all entering into the mix. For an economist, this could be the best of times.