Real Earnings: +0.1%; Over-Year: -2.4%; Hourly Earnings: +0.6%; Over-Year: +4.7%; HWOL: +6.3%
IN A NUTSHELL: “Could the fastest increase in consumer prices in forty-years lead to the Fed raising rates by 50 basis points in March?”
WHAT IT MEANS: Businesses are worrying about rising input and wage costs, while households are distressed at the surging consumer prices, and they both have cause for concern. Inflation jumped again in December, though the pace was down from what we saw in October and November. Since December 2020, prices were up 7%, an increase not seen since the wage/price inflation spiral days in the early 1980s. Excluding food and energy, the rise over-the-year was the greatest in thirty years. In other words, the “bad old days” are back. Not really, conditions are different, but inflation is showing few signs of decelerating. In December, there were strong increases in just about every major component except energy goods and services. Commodity costs, excluding food and energy, have risen nearly three times as fast as services, as medical and shelter costs were up more moderately than most other components. Used vehicle prices continue to skyrocket as new vehicle supplies remain tight.
Wages may be surging, but consumer prices are going up just as fast, if not faster. Hourly earnings jumped in December, but when adjusted for inflation, they were up minimally. Worse, over-the-year, real wages declined sharply. Households are seeing their purchasing power disappear and that is not good news for the economy.
The Conference Board’s Help Wanted OnLine index rebounded sharply in December, after having cratered in November. This measure doesn’t usually bounce around this wildly, but the trend is up and the level of want ads is at a record high. To the extent that firms can find available workers, it looks like they will be hiring just about every one of them.
FED POLICY IMPLICATIONS: Prices are rising at levels not seen since former Fed Chair Paul Volcker decided it was time to use the nuclear option – massive interest rate increases that would crush the economy and squeeze inflation pressures out of the system. The time to face the inflation threat, even if it is currently not close to what it was forty years ago, has arrived. Fed Chair, Jay Powell is not likely to go the Volcker route, but he made it clear that the days of feeding the economic and market beasts with massive liquidity are coming to an end. Today’s report backs for the Fed’s view that it not only has to stop adding support to the system, but it needs to begin withdrawing it, both in terms of raising rates and reducing its balance sheet. Don’t be surprised to see the asset purchases end by March and the rate hike process begun at the March 15-16 FOMC meeting. How fast will interest rates be increased and liquidity be withdrawn from the economy? The consensus is for the Fed to raise rates at its usual pace, 25 basis points every other FOMC meeting, or one percentage point a year. However, that may not be the strategy. We get two more inflation reports before the March meeting and if they continue to show inflation accelerating, I do not rule out a 50-basis point increase. That would have to be signaled beforehand, but it would show that the Fed means business. Its biggest concern is that higher inflation will become embedded in expectations, which would require even stronger action (no, not the nuclear approach). Mr. Powell commented at his reappointment hearing that he still felt that the supply chain-related issues would fade, though he has pushed that timing out toward later in the year. A sooner-than-expected deceleration in inflation would provide the Fed some breathing room, but that doesn’t seem to be the likely case. Regardless, the funds rate is going up and barring an economic collapse, look for it to rise at least two percentage points over the next two years.