Sticky inflation and a strong labor market: The perfect excuse for the Fed to stay put on rates.
KEY TAKEAWAYS
MY HOT TAKE
Teapots and tempests. It’s inflation day! Yes, today we get the latest read on consumer inflation when the Bureau of Labor Statistics (BLS) releases its closely watched Consumer Price Index / CPI. It is a popular series despite the fact that it is far down on the Fed’s list of trusted sources. My regulars know that the Fed prefers to look at the PCE Price Index, which also tracks consumer inflation but with some nuances that make it more accurate—at least from the Fed's perspective. CPI’s primary reason for existence is to set Social Security increases to meet inflation, but it is popular beyond that, possibly because maybe the BLS is better at marketing than the Bureau of Economic Analysis (BEA). Probably not, it’s more likely that the 73 million people who receive Social Security are interested to know if inflation will leave them behind. In any case, the popular with the crowd / not so popular with the Fed number is due out this morning, and there is a lot of tension in the markets building up to it.
I find it interesting that the market, at this stage, is so reactive to these numbers, given that the Fed has made it quite clear that it is “watching and waiting,” when it comes to rate policy. That really means “fugetaboutit” in New York talk. That means NO RATE CUTS UNTIL INFLATION GETS TO 2% OR THE 💩💩 HITS THE FAN. Let’s do a quick data dive to see where we are.
Let’s start with the Fed’s dual mandate, which basically compels it to maintain a healthy labor market while simultaneously keeping inflation in check. The former seems to be in a pretty good place. According to last Friday’s monthly BLS release, the unemployment rate slipped to 4%. Check out this chart of the unemployment rate and keep reading. Be patient—we’ll get there.
As you can see by this chart, we have come a long way since the unemployment rate spiked as a result of the pandemic lockdowns when it topped out at nearly 15%. By early in 2023 the unemployment rate got as low as 3.4% which is lower than it was just prior to the pandemic. However, if you look carefully at the chart, you will notice that it ticked up slightly early last year (the grey lines show very rough trends). That uptick concerned the Fed, and the bankers cited it as a primary driver for their first, oversized, 50 basis-point rate cut. However, it appears to have stabilized since and even declined slightly last month. This likely abates the concern of the Fed on Mandate #2.
Now let’s look at Mandate #1, inflation. Check out this CPI chart and keep reading.
On this chart, if you follow the grey lines, you will see inflation come down steeply through summer 2023 then decrease steadily until early fall of last year. And then—it should be obvious—it started to climb slowly to 2.9% (December). Economists are expecting todays release to remain at 2.9%, but you can see by the chart the recent trend appears to be diverging away from the elusive 2.0% target.
Now let’s go over what we just observed. On both mandates, labor market and inflation, the Fed has made great progress. More recently, the labor market seems relatively stable after a brief scare last year. I say “relatively,” because, looking back at history, 4% is a low unemployment rate—it has only gotten this low two other times since 1970. While the Fed needs to continue to watch it carefully, it can hardly be considered a crisis that warrants immediate rate cuts.
Inflation is another issue altogether. Though great strides have been made here as well, it is clear that there are some sticking points. Namely, housing which is still high, but thankfully, ticking down, but only by tenths and one hundredths of a percent (that’s slow for you non-math types). Insurance costs and healthcare also continue to prove problematic for inflation. These items all fall into the category of “necessary to exist,” making it challenging for many. That is also challenging for the Fed, because housing inflation will remain high until rates come down, and insurance and healthcare inflation cannot be controlled by monetary policy. The bottom line here is that this divergence from the Fed’s target does not necessarily justify immediate rate cuts either. Before I conclude, I think it is important to drop one more chart on you. Please bear with me, we are so close. Have a look.
This is one of my favorite Bloomberg charts (ECAN). You can see that food inflation has been ticking up rather noticeably since last fall. If you look closely, you will find the Meats, Poultry, Fish, and Eggs category is largely to blame. Those increases have a lot to do with Avian Flu and herd thinning due to bad weather conditions, drought, and increasing feed costs. Mostly, acts of Mother Nature, which is, under normal conditions, tolerable, but when inflation is so closely being monitored by not just the Fed, but also EVERY FED-OBSESSED TRADER IN THE WORLD, upticks can turn into… er, gastric discomfort. That is my way of saying “watch this closely today.”
Hopefully, this data dump will explain why the Fed is on hold with rate cuts and why it will continue to remain on hold—for now. If you throw the new administrations aggressive activities which have the potential to add to inflation and economic weakness, you get an even more on-edge group of policy makers. Trust me, they are on edge. Further, it is not likely that those guys and gals are going to do anything you want anytime soon. You can trust me on that as well. I will leave you with one final chart which shows expected Fed Funds Rate in December, based on Futures. You will see what looks like 50 basis points lower from where they are today. The numbers behind the chart show only a 40% chance of a second 25 basis-point rate cut. That is good, but not great odds. This morning’s number has the potential to move those odds, so if you care, pay attention.
YESTERDAY’S MARKETS
Stocks bounced around yesterday ultimately closing mixed as Chairman Powell told lawmakers what we all know “we are on hold,” and we don’t care what the President does (they do 😉). All eyes are on this morning’s CPI release, and 10-year Treasury Note yields reversed their downward trend and have been ticking up in recent sessions—this could dampen what’s left of the post-election equity bull run.
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