Stocks inched higher yesterday as bets for more aggressive rate cuts increased with weak economic data. New Home Sales declined by -11.3% in May surprising even the most pessimistic blue-chip economists – a possible sign of cooling off in housing.
You say tomato, I say… tomato. This is one of those weeks where traders are trying to look focused on the daily activities. I used the word “trying,” not because next week is the official, unofficial start of summer holiday with Independence Day. No, I didn’t mean to imply that they were “f’working,” a predominantly millennial/gen Z term which is a contraction of the phrase “fake working.” F’working typically occurs on summer Fridays and days before holidays. They are on their computers, but most likely online shopping or reposting food pics, taking the occasional work call and opening emails only from their bosses. It’s not that. There is plenty to focus on this week as far as economic releases go, but there is one that everyone… EVERYONE is waiting for, and that will be released tomorrow. Sure, today’s Gross Domestic Product / GDP release has all the looks of an important number, and it is, but really, it is the third revision of US economic output from LAST QUARTER, as in the one that ended in March… um… we are almost done with June.
It is not likely that today’s GDP release will move the needle for Fed policymakers. Yes, we will also get Preliminary Durable Goods, Pending Home Sales, Initial Jobless Claims, and Kansas City Fed Manufacturing Activity Index, which, collectively, can sway the Fed’s mood, but what traders and the FOMC are all waiting for is tomorrow’s PCE Deflator. I know it has a weird name which probably means nothing to you, but if you read my note often enough, you know that this inflation figure is the favored metric of the Fed’s. Mainstream media talks about the Consumer Price Index / CPI because not only is its title more descriptive, but also because it affects changes in Social Security. But, if you are concerned about interest rate policy, you should pay more attention to the PCE Deflator.
So, what is the difference between the two inflation measures? Well, to start, the CPI measures expenditures by URBAN consumers. Sorry suburbanites and rural denizens, what you pay for your stuff doesn’t count. Weird, right? I don’t make the rules, I just TRY to explain them. The PCE Deflator includes a much broader sample of geographic zones which should, in theory, provide a more accurate view. Actually, in reality, I know what a roll of toilet paper costs in New York City versus a suburb just 45 minutes from Midtown, and there is a huge difference.
Let me ask you a question. Do you rent videos and watch them while eating frozen TV dinners? You probably don’t, but at some point, in the past, you probably DID. Today, you are more likely to order in from DoorDash and watch a Netflix series or an online movie rental. That is because consumer habits change over time. In fact, they change more frequently than you would think. Just think about the breakdown of the things that you buy (goods and services) today versus, say, 2 years ago. That brings us to another major difference between the two inflation measures. The CPI measures the price of a fixed basket of goods and services and compares the cost to prior periods. By “fixed,” I mean that the weighting of the constituents does not change much, if at all. I am sure that you can still buy frozen TV dinners, but the importance to you is vastly different than it might have been in the past. They should therefore be weighted less in today’s basket. That is another area where PCE Deflator differentiates itself from CPI. It has dynamic weighting based on retail patterns. That not only provides a more contemporary, accurate reading, but it also makes the measure less volatile. Check out this chart of CPI and PCE Deflator plotted together, then follow me to the close.
You can see on this chart how the green line which represents CPI is much more volatile than the black line representing PCE Deflator. If you were trying to get an idea of the trend of prices, I am sure that you would prefer the black line over the green. Now that we are looking at it, can you see the trend? That’s right, it is certainly moving in the right direction. Tomorrow’s release is expected to show PCE Deflator at +2.6%, lower than last month’s +2.8% print. If it does, it would further strengthen the clear trend of disinflation, WHICH IS WHAT THE FED WANTS. You can also see just how close we are to the Fed’s self-prescribed target. Did this conversation get you in the mood for a frozen TV dinner? Well, if you are willing to take a risk and eat the scalding-hot, unrecognizable dessert after savoring the tasteless mashed potatoes, go out and get yourself one. You may have to search far and wide, as their supply is sparse. Sparse supply just means you will have to pay a lot for it – but wait won’t that affect the CPI? Finally, if you don’t know what a TV Dinner is, you are probably a millennial or a gen Z, in which case you should get back to your f’working and DoorDash some sushi to your desk 🍣🍥.
YESTERDAY’S MARKETS
NEXT UP