KEY DATA: CPI: +0.6%; Excluding Energy: +0.3%/ Retail Sales: +0.4%; Excluding Vehicles: +0.8%/ IP: -0.3%; Manufacturing: +0.2%
IN A NUTSHELL: “Another inflation number, another reason to for the Fed to hike rates.”
WHAT IT MEANS: Yesterday I noted that any number that shows that inflation is rising is a warning that the Fed is going to raise rates soon. Well, the sharp rise in the Consumer Price Index in January is one of those numbers. Yes, energy costs did surge, but in her testimony, Chair Yellen said that inflation including food and energy matters. Over the year, top line inflation was 2.5% and even excluding food and energy, the so-called core, it was above the Fed’s 2% target. The gains in January were across the board with only a decline in used-vehicle prices keeping the index from rising even faster. Food at home was flat but if you went out to eat, you paid a lot more. Thankfully, fresh donut prices were down.
Rising prices is not keeping consumers from spending. Despite a slowdown in vehicle demand, retail sales rose solidly in January. People hit almost every type of store as sales of clothing, appliances and electronics, building supplies, sporting goods, food and health care products rose solidly. We didn’t buy a whole lot of furniture and interestingly, online sales were flat. That may have been due to the fact that we were eating out like crazy.
Industrial production eased in January, but as usual, the headline number didn’t tell the whole story. We had one of the warmest January’s on record, at least where I live, and utility production tanked as a consequence. But manufacturing output increased moderately and the petroleum sector continues to rebound, with output up significantly. The vehicle sector continued its wild up and down swings as assembly rates tanked after having increased in December. With new models coming out randomly, I suspect it has become hard to seasonally adjust these data.
So far, February hasn’t been a particularly good month for builders. The National Association for Home Builders index slid as traffic declined. That led to a pullback in expectations.
MARKETS AND FED POLICY IMPLICATIONS: The data are becoming clear as to both growth and inflation. Consumers are spending money at a very solid pace and that is putting a floor under growth. But inflation is accelerating. The Consumer Price Index has moved above the Fed’s target, as have a variety of other special measures that a number of Federal Reserve Banks have created. But the Board considers the Personal Consumption Expenditure price index the gold standard and we will not get that until we get the income and consumption numbers on March 1st. I expect that measure to also show inflation over the year rising by 2% or more. So, does that bring the March FOMC meeting into play for a rate hike? I think that is too soon, especially since Chair Yellen commented that fiscal policy will play a role in the Fed’s decisions. We are months away from any clear indication what those tax cuts may look like. I think the May meeting holds out great possibilities and if not then, I would be surprised if they don’t do something in June. So, we are looking at a move in the next three to five months. If that is the case and a decent sized fiscal stimulus package is passed, I expect the Fed to hike again in September and at least one other time before the end of the year. A December half-point increase would not be out of the question if the economy picks up steam and inflation continues to accelerate. I don’t believe equity investors have priced that in and the bond market seems to be just starting the process – but not with a lot of conviction.