Sticky, icky inflation

Stocks sold off on Friday as inflation proves to be unbreakable to the Fed’s aggressive assault. Portfolio manager rebalancing for the quarter end added to an already volatile market..

New normal? Inflation continues to evade the Fed, according to the latest numbers, released last Friday. The PCE, or Personal Consumption Expenditures, Deflator ticked up higher than expected in August and that is cause for concern. Is the Fed’s aggressive rate hiking completely useless?

To start, let’s take a high-level look at the latest inflation figures. In the name of brevity (which is not a skill I possess) we will stick to the outliers. Cereals and Bakery Products: +1.1%, Eggs: +2.9%, Fresh Vegetables: +1.2%, Sugar and Sweets: +1.5%, Cosmetics/Perfumes/Bath/Nail Preparations/Implements: +2.3%, Newspapers and Periodicals: +2.7%, Electricity: +1.5%, Natural Gas: +3.5%, and Air Transportation: +3.8%. Looking at that list, I am sure that you buy items in at least one of those categories on a regular basis. Now, bear in mind that these figures are monthly changes! What that means is that most Americans are experiencing pressure on their pocketbooks… every month. That is why the Fed is unrelenting in what appears to be its pursuit of economic calamity. Altruistically speaking, the Fed wants to make yours and my life better by fighting inflation. Politically speaking, inflation is a bad look for the government.

You might have noticed that most of the categories above have very little to do with interest rates. I suppose that some people buy eggs on credit, but most don’t. I will give you Air Transportation, but that is pretty much it. Consumers tend to use credit for big-ticket items such as cars, homes, and appliances. How are they faring? Well, New Motor Vehicles has not shown signs of slowing, having gained in price by +0.9% in the latest report. Major Household Appliances have eased in price, falling by -1.5% in August after falling by -2.2% in July, and has been trending downward. So, that is 1 for the Fed and 1 for stubborn inflation. Finally, the next big one, housing. Housing is not a large component of the PCE figure, but we do know, based on economic releases in the past 2 weeks, that home prices are not only turning down, but they logged the largest month over month decline in the history of the indexes that follow it. I suppose that makes it 2 for the Fed and 1 for inflation. But that doesn’t cover the full picture. In order to get a more robust view of housing, we need to turn to the Consumer Price Index / CPI, which was released a few weeks back. According to the latest report, which covers the same period as last Friday’s PCE Deflator, Rent of Shelter continued its rising trend, gaining +0.7% for the month. That makes it +6.3% greater than it was a year earlier. Home prices are going lower, but rents continue to rise, so perhaps we were hasty in awarding the Fed that win. The Fed knows all this, which is precisely why its messaging of hardcore inflation fighting will not likely change anytime soon.

Speaking of that, there is perhaps one other item which is strongly impacted by rising interest rates. Are you thinking what I’m thinking? Of course, you are. The equity markets are impacted by all the Fed trash-talk and interest rate hiking. Since the Fed started its campaign, equity markets have erased significant gains, shrinking savings accounts and retirement funds, leaving investors on edge. You may not be surprised to hear this but, consumers tend to spend less when their savings are being sacked by falling markets. What’s more, even consumers who don’t own any stocks tend to lose confidence when the stock market is falling. Therefore, I suppose we can, perhaps give 1 more point to the Fed in its fight with inflation.

There is a category which I have not covered yet, which I will conclude with, and that is Gasoline and Other Motor Fuel. Remember that? That was the first real challenge for consumers when gas prices spiked earlier in the year. The spike was attributed to a long-running supply decrease by OPEC+, the war in Ukraine, and increased demand as more folks headed back to work. The good news is that prices at the pump have been coming down, specifically, according to last Friday’s number, by -10.5% for the month. It would be hard to give a point to the Fed on that as declines have had little to do with interest rate policy. But wait, there is an indirect impact. Higher interest rates have caused the US dollar to gain in value, and crude oil, which trades in US Dollars, has been under pressure due to the currency’s recent strength. There is one other thing, an economic slowdown always diminishes demand for crude oil, which has also put pressure on the price per barrel. Those declines in crude will ultimately ensure that gasoline prices continue to trend lower, or at least, stay stable.

As you can see, inflation is a complicated enemy of consumption. The Fed is putting forth its best efforts to kill the housing market and collar corporate borrowing. Consumer confidence, however, remains strong, and it is likely to continue to do so as long as unemployment stays low. The Fed would be happy to see the labor market slacken up a bit which would also play a big role in slowing inflation. We will get some input on how well the Fed is doing on that front as we get JOLTS Job Openings and the monthly employment numbers from the Bureau of Labor Statistics, later this week. For now, markets continue to factor in a 66% probability for another +75 basis-point hike next month and an implied Fed Funds rate of 4.21% at the end of the year. Despite all the rumbling and grumbling last week, those probabilities changed very little, even pulling back a touch. We have a long way to go before the prior hikes propagate through the market and begin to have positive impacts on consumer prices. After all this point-keeping, it is still not clear who is winning the game, is it. It is not until we start to see more of those categories trending down that we can expect the Fed to start speaking about easing up, when finally, you and I can begin racking up some points in our columns, once again.

LAST FRIDAY’S MARKETS

Equities sold off on Friday, capping a losing quarter as portfolio managers reshuffled amidst a stronger than expected inflation figure. The S&P500 lost -1.51%, the Dow Jones Industrial Average traded lower by -1.71%, the Nasdaq Composite Index sold off by -1.51%, and the Russell 2000 slipped by -0.61%. Bonds fell and 10-year Treasury Note yields added +4 basis points to 3.82%. Cryptos added +0.38% and Bitcoin declined by -0.43%.

NEXT UP

• S&P Global Manufacturing PMI (Sept) is expected to be in line with prior estimates at 51.8.
• ISM Manufacturing (Sept) may have declined to 52.0 from 52.8.
• Fed speakers: Bostic and Williams.
• Later this week: Factory Order, Durable Goods Orders, JOLTS Job Openings, ADP Employment Changes, Change in Nonfarm Payrolls, and Unemployment Rates.