KEY DATA: CPI: +1.2%; Over-Year: 8.5%; Ex-Energy: +0.4%; Energy Commodities: +18.1%; Food: 1%/ NFIB: -2.4 points; Expectations: -14 points
IN A NUTSHELL: “Let’s hope this is the peak, as we really don’t want to hit double-digit inflation numbers.”
WHAT IT MEANS: Yes, Mr. Powell, there is inflation. In March, the first full month after the start of the Russian invasion of Ukraine, energy prices skyrocketed, building on the sharp rise posted in February. But let’s not blame the inflation just on energy. Food, clothing, medical care, transportation, and shelter were all up sharply. Excluding energy, prices rose sharply but not outrageously. I guess that is something small to hold onto. That said, food prices are pressuring consumers greatly. If you go through the details of food costs, every category is showing large increases over the year. With rent also jumping, the staples of life, food, energy, and shelter, are likely forcing some people to do without.
Given the soaring inflation, it was hardly a surprise to see small business optimism fall in March. The National Federation of Independent Business reported that owners are not a bunch of happy campers. Maybe the most eye-opening number in the report was the index that measures whether owners are expecting better conditions over the next six months: It cratered and hit the lowest point in the 48-year history of the survey. Given we have been through a financial meltdown and a pandemic during that period, it shows that the key small business sector is really depressed. As for prices, the net percent saying they raised prices also hit an all-time high. Everyone is on the price hike bandwagon, which does not bode well for future inflation.
IMPLICATIONS: Not that long ago, the Fed wanted inflation to pick up. Well, it got what it wanted and a whole lot more. Businesses of all sizes, in all industries, are raising prices and that is causing increases in costs throughout the supply chain. With labor shortages pressuring firms to raise wages, we are in the midst of a wage-price inflation cycle that will require extreme action on the part of the Fed to rid the economy of the spreading inflation threat. I am not talking Paul Volcker nuclear option approach, but given how modest rates have been for so long, it may seem like that to many. The FOMC is meeting on May 3,4 and it would be a shock if there isn’t a rate hike of at least 50 basis points. Indeed, I cannot exclude a 75-basis point increase. The last time that was possible (almost thirty-years ago), I was asked by the CEO of the bank I worked for the probability of that happening. I responded “zero”. A note indicating that Fed did raise rates that much was brought into the meeting while I was explaining why it wouldn’t happen, so I will never rule out a 75-basis point increase again. There are likely to be some members who will be pushing for a big statement. Inflation should moderate, if only because some of the biggest increases are behind us. But there is a difference between decelerating and low. Since monetary works with a lag, don’t expect major progress on the inflation front even if the Fed acts aggressively. The ability of any Fed to sharply raise rates to slow extremely high inflation, while not driving the economy into a recession, is limited, especially given factors such as war that are out of its control. We are talking about art here, not science, and there is little history of this Fed painting pretty pictures. For me, the likelihood of a recession in the next year has now moved over fifty percent. Indeed, while a soft-landing is nice to think about and something to which the Fed should aspire, ridding the economy of inflation is job one.