December Consumer Prices, Real Earnings and Small Business Confidence

KEY DATA:  CPI: +0.2%; Over-Year: +2.3%; Ex-Food and Energy: +0.1%; Over-Year: +2.3%/ Real Hourly Earnings: -0.1%; Over-Year: +0.6%/ NFIB: -2 points

IN A NUTSHELL:  “Despite reasonably tame inflation, household spending power continues to fade.”

WHAT IT MEANS:  With the Fed happy with its position on interest rates, we have to ask what could knock it off its stand.  They could hike rates if inflation or growth accelerates sharply or even reduce rates further if the opposite occurs.  Today’s data contain some insights into both growth and inflation.  On the household cost side, the Consumer Price Index rose moderately in December.  Energy prices jumped, as expected and food costs were up moderately.  Taking out those two volatile components, the so-called core index rose minimally.  There are always outliers and in this report there were two.  First, medical costs, including both commodity and services, are rising faster and faster.  Medical costs had been surprising tame for much of the past decade but that is changing.  It may be too early to conclude this but it is beginning to look like the current laissez-faire approach to health care is allowing providers to ramp up prices.  On the other hand, used vehicle prices cratered in December.  The record sales we saw are now creating huge inventories of vehicles coming off lease and that is an issue for dealers.  Overall, though, it looks like inflation is now running at a pace near the Fed’s target.   

On the growth side, my concern has been and will likely continue to be the diminishing gains in consumer purchasing power.  This is defined as the increase in earnings adjusted for inflation.  Real hourly earnings fell in December and the gain was well under 1% over the year.  When hours worked were factored in, inflation-adjusted weekly earnings were absolutely flat since December 2018.  It is hard for the average household to keep up the spending we have seen if their spending power is going nowhere. 

Meanwhile, small businesses remain pretty upbeat.  Yes, the National Federation of Independent Business’ Optimism Index eased in December.  But the level remains high and the components are still fairly strong.  But there is a warning sign in the report.  Earnings growth continues to fade, led by a growing softness in sales.  If the small business sector is the canary in the coal mine, the bird is still chirping but not quite as loudly as it had been.     MARKETS AND FED POLICY IMPLICATIONS:We get the first reading on fourth quarter growth in two weeks.  It should be in the 2% range, meaning the gain for the year should be about 2.3%. Basically, growth started off strong but faded as we went through the year.  Will that softening in growth continue?  One major factor restraining activity, especially capital spending, was the trade war.  As long as that doesn’t get out of control again, business spending may improve.  However, the deceleration in household earnings is likely to force consumption growth to slow.That likely means this year should be slower than 2019.  The January Blue Chip consensus is for 1.9% growth this year. I am a member of that survey panel and that is my forecast as well.  That may be enough to keep the unemployment rate relatively stable (I expect it to start rising slowly in the second half of the year), but it raises serious questions about corporate earnings.  Profits were soft last year and fading growth doesn’t point to better gains this year.  It could take additional financial manipulation, such as further stock buybacks, to keep equity prices up.  So, the Fed may be satisfied with inflation and growth right now, but that doesn’t mean everything is as beautiful as the members seem to believe it to be.