October Wholesale Prices and Mid-November Confidence

KEY DATA: PPI: +0.6%; Energy: +2.7%; Food: +1%/ Sentiment: -0.3 point

IN A NUTSHELL: “Despite the surge in producer prices, there are few indications that inflation will accelerate sharply.”

WHAT IT MEANS: Is inflation something the Fed should be concerned with? It doesn’t currently believe so and today’s Producer Price Index increase really doesn’t change things very much. First of all, the large rise was driven by jumps in energy and food. Petroleum costs have hit a downdraft and it isn’t clear that food prices will continue to rise sharply. Also, the change over the year in the index has decelerated over the past few months. That is not say the October report did not contain any potential issues. Transport costs are increasing and with growth strong, they are likely to continue putting pressure on distributors. Construction expenses are skyrocketing. And price pressures in the pipeline are picking up. Add to that rising labor expenses and firms will have to start determining if demand is strong enough to support faster increases in prices. I suspect that is what will happen, so look for consumer prices to begin accelerating slowly over the next few months.

Consumer confidence remains on the moon. That’s not quite Mars, but pretty close. The University of Michigan’s mid-month reading of consumer sentiment fell only modestly in November. Still, the index is on track to record the highest level since 2000. The dot.com bubble hadn’t burst yet and confidence did crater afterward. A similar result occurred when the housing bubble burst. If the economy tails off over the next year, as expected, look for confidence to start deteriorating.

MARKETS AND FED POLICY IMPLICATIONS: The Fed, as expected, made no change in rates yesterday, in part because the members were fairly sanguine about inflation. They noted that “On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.” In other words, the strong growth they see is not threatening. But that doesn’t mean there is no reason to raise rates in December and going forward. Remember, the Fed is simply trying to get back to neutral, which Chair Powell has stated is far from the current level. To the members, as long as there are no deflationary pressures at work, the need to move to neutral will dominate. And also remember that the Fed has a dual, not a triple mandate that would include the stock markets. So if increasing rates has a negative impact on equity prices, so be it, unless it sets off a major stock market correction. Why that would happen with an economy that is as strong as the current one and which is being propelled by massive fiscal stimulus is something I cannot figure out – and something that doesn’t seem to worry the Fed right now. So, look for further rate hikes in 2019, even if growth moderates, which it likely will.