October Consumer Prices and Real Earnings

KEY DATA:  CPI: +0.4%; Year-over-Year: 1.8%; Ex-Food and Energy: +0.2%; Year-over-Year: 2.3%/ Real Hourly Earnings (Y-o-Y): +1.9%; Real Weekly Earnings (Y-o-Y): +1.6%

IN A NUTSHELL:  “Inflation is firming and with hours worked down and wage increases flattening, household purchasing power gains are slipping. ”

WHAT IT MEANS:  You know all that room the Fed had to cut rates because inflation was going nowhere, well that is no longer the case.  Consumer prices jumped in October, led by large increases in energy, used vehicles and medical services.  There was even a solid rise in food costs, though this month it was food at home more than restaurants. The one component that is not showing signs of rising costs is apparel, which posted another sharp drop.  Imported apparel prices are up modestly over the year and it looks like the Chinese devaluation of their currency has had its intended effect of partially insulating the country from sharp rises in prices due to tariffs.  Excluding the volatile food and energy components, retail prices rose moderately.  But the real information is in the year-over-year numbers.  The overall index remains above the Fed’s 2% target and the core/ex-food and energy component is pushing 2%.  While the Fed prefers the Personal Consumption Expenditure price index to the CPI, this is still an indication that inflation is no longer something the Fed can use as an excuse to do the inexcusable, which is to cut rates again.

With inflation rising, consumer purchasing power is faltering.  Inflation adjusted (real) wages declined in October, as did real weekly earnings.  Once again, the key numbers are the year-over-year changes and the growth in hourly and weekly earnings remains tepid.  It is hard to sustain consumer spending at a 3% pace, which we have seen for most of this year, when purchasing power is increasing at less than 2%.  Something has to give and while savings may be the first casualty of the earnings slowdown, spending will likely be next.

Yesterday, the National Federation of Independent Businesses released its October survey and optimism posted a small increase.  Eight of the ten components were up.  The economy may be slowing, but the early-warning sector, small businesses, is not signaling any major faltering in economic activity.  I guess the Fed doesn’t read the report (just kidding, Dunk). MARKETS AND FED POLICY IMPLICATIONS:There is little reason for the Fed to cut rates again anytime soon.  Inflation is not trending downward, the trade war has moved back, at least for now, to trade skirmishes and longer-term interest rates have risen in response to the easing in tensions.  Indeed, in today’s testimony in front of the Joint Economic Committee of Congress, Chair Powell seemed to take a victory lap, though it probably had little to do with the Fed’s actions.  He noted: “Looking ahead, my colleagues and I see a sustained expansion of economic activity, a strong labor market, and inflation near our symmetric 2 percent objective as most likely. This favorable baseline partly reflects the policy adjustments that we have made to provide support for the economy.”  His puffery not withstanding, the economy is just where so many of us thought it always was and would be, if and only if the trade war fears were eased or even alleviated.  That is, modest to moderate growth and inflation near the Fed’s target.  Thus, there is little reason to make any additional moves – as long as the trade skirmishes don’t break out into full-fledged war.  Of course, as I have argued repeatedly, lower interest rates do almost nothing to counter the fears created by a political decisions to impose higher tariffs, but that is not likely to resonate in the halls of the Federal Reserve building.  Regardless, the best estimate is that we could see the Fed on hold for an extended period (assuming no trade war).  The Fed Chair made one other major comment in today’s testimony.  He made it clear he was concerned about the growing, seemingly out of control U.S. budget deficit.  And he should be worried.  It is likely that the current fiscal year’s deficit will be well in excess of one trillion dollars and if a recession hit, fiscal policy could be in a straitjacket.  Given the Fed also fitted itself with a straitjacket by lowering rates to a level that gives it minimal room to cut further, a recession could be extremely hard to counter.