The markets have gotten off to a strong start this year, with all the main equity indexes advancing. Bond yields have also backed off a bit leading to gains for fixed income. The general theme underlying the move in both stocks and bonds is pretty straight forward – moderating inflation could very well lead to a less hawkish Fed in the months to come. Now whether this proves to be the case is obviously up in the air, but the inflation report released on Thursday certainly supported this narrative.
The CPI number for December came in at +6.5% on a year-over-year basis, down from +7.1% in November. Inflation has now slowed for six straight months. Prices in December were actually down -0.1% from the previous month, as you can see below.
The slowdown is mostly a result of declining energy costs as gasoline became less expensive. Used cars and airline fares also fell in price, while gains in food prices slowed. Housing costs, however, continued to climb.
The chart below is interesting – it shows that the prices for goods is contracting and that service inflation has slowed significantly.
Another way of showing this is to graph the CPI number less rents (aka inflation minus the bad stuff). We now have deflation ex housing on a monthly basis.
But rental prices remain one of two big wildcards when it comes to inflation. Goldman Sachs, for what it is worth, thinks the rent growth should soften in the months to come. Their main point is that rental rates are a lagging data point. Listing prices have flatlined, and it is only a matter of time before this is reflected in the CPI numbers.
We will have to see. It’s hard to model both the housing market and how poor affordability translates into rents.
But for now, the theme of moderating inflationary pressures is supporting the markets because it means the Fed may be nearing their end point. Investors are betting on a quarter point hike in the Fed Funds rate on February 1st, and another quarter point hike six weeks after that.
And that could be it. But much will depend on what happens in the labor market.
Jobs and Wages
The other major wildcard in the inflation debate concerns the labor market. This week’s initial unemployment claims number showed continued tightness in the jobs market. As you can see below, initial claims are stuck below pre-COVID lows.
The Fed has been very verbal about wanting to see wage gains moderate. There are hints of this in one measure of wages, the Atlanta Fed Wage Tracker (blue line below). But this is modest at best.
To truly have confidence the Fed will step aside in March we will need to see a more durable slowdown in wage growth. Again, time will tell.
(Other) Charts We Found Interesting
- Shipping costs are almost back to normal.
- Eggs are in a bull market.
- Per capita oil consumption by country and/or region.
- India is on track to surpass China as the most populous country this year. The coming fall in China’s working age population is stunning!!
- California’s snowpack – looking good for once.
- SpaceX’s Starship is inching ever closer to its first launch. This thing is big…. very big. Oh, and it has twice the trust of the Saturn V.
- Half of all Californian’s live below the red line!!!
Have a good weekend
Happy new year everyone!!
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