It was a mixed bag this week with investors pulled in different directions due to changing perceptions about inflation and what it might mean for monetary policy in the months to come. The main indexes didn’t really do much, but the rates market moved a decent amount. Ever since early October last year both stocks and bonds have been rallying on the idea that inflation had topped out and that monetary tightening was likely to end by March or April of this year. This week proved to be the first meaningful test of this thesis.
In a way it really started two weeks ago with the blowout jobs report. But at the time that number was viewed as something as a statistical fluke. But this week’s data built on the same idea that 1) the economy really isn’t slowing much, 2) inflation might be slowing, but not very quickly, and 3) the Fed has more work to do.
Sticky Consumer Price Inflation
There were a couple inflation reports this week. The first was the consumer price inflation (CPI) number. Both headline and core came in above expectations.
The inners of the report pointed towards sticky inflation in the services sector. Consumer spending is motoring right along, putting pressure on service prices.
The other surprise was found in the rental number. The so-called shelter-CPI (a measure of rent inflation) continued to increase despite softening rents being observed elsewhere. There’s almost certainly a timing issue here and the shelter-CPI stat should soon start to slow, but we haven’t seen it yet.
The other inflation report was the producer price inflation (PPI) release. This shook the markets a little more than the CPI for the sole reason that inflation in January actually accelerated. The green and red bars in the chart below show the monthly change. Prices were down in December, but accelerated much quicker than expected in January.
Markets Price in a More Aggressive Path
Taken together both reports paint a picture of inflation that might be coming off the boil, but nowhere near as quickly as the markets had started to price in lately. For example, Fed Fund futures were actually pricing in rate cuts later this year based on the assumption the economy would probably fall into a recession and the Fed would respond accordingly. This is looking less and less likely.
For example, the chart below shows the anticipated path for the Fed Funds rate both at the start of February and on Thursday of this week. At the beginning of the month investors were betting on rates peaking at roughly 4.9%before falling to 4.2% by the beginning of next year. However, now the peak is forecast to be close to 5.3% with very little in the way of cuts being priced in.
This seems much more reasonable, but it also means the Fed is probably hiking through the summer, and we can’t rule out another 50bps hike at some point this year if we see another hot inflation report.
(Other) Charts We Found Interesting
- The other factor that contributed to the change in rate expectations are the falling odds of recession. The latest retail sales report handily beat expectations, adding to the soft landing (or no landing) idea.
- If you want a sign that inflation might actually underwhelm this year, look no further than the cover of The Economist. They’ve been a pretty good contra indicator the last few years.
- The FT dug into how much is likely to be spent on renewable energy over the next few years due to the Inflation Reduction Act. They get pretty close to $1 trillion by 2031.
4. This is just part of a broader capital expenditures ‘boom’ in the United States that should total roughly $300 billion in 2023.
- The average credit card rate hit the highest level in living memory this week.
- There’s roughly $1 trillion outstanding on credit cards and other revolving plans. At close to 20% interest!!
- The cell phone has changed our world in numerous ways. This picture from the Lakers game a few days ago captures the brave new world. Everyone was filming LeBron except for one guy sitting right up front. Love him or hate him, that’s the right way to watch a game!!
Have a good weekend.
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