US inflation primed to ‘turn and burn’

At long last, markets were reinvigorated as the Federal Reserve eased to quarter-point rate hikes on February 1st.

As Memphis Raines put it, ‘Champagne would fall from the heavens, doors would open and velvet robes would part.’

The S&P 500’s close was near a 6-month high the day following the announcement.

But the glee was to be short-lived.

Personal consumption expenditure (PCE)

In this case, Friday’s much-awaited PCE report was a major letdown.

Contrary to the inflation-is-(largely)-under-control narrative, the data showed that the Fed’s favoured inflation indicator headed considerably higher to 5.4% YoY, well over December’s 5.0%.

On a monthly basis too, the number came in at an elevated 0.6%, the highest since March 2022 which was at the outset of the Russia-Ukraine war.

Real goods inflation that had turned negative two months in a row surged to 2.2% MoM in January 2023.

Similarly, real services inflation which was unchanged in the previous report jumped sharply by 0.6%.

Consumer spending was reported at unsustainably high levels of 1.8%, compared to market estimates of around 1.4%, and was well above the next highest reading of 0.8% recorded in July.

Such a ferocious rise across both goods and services would likely spell disaster for lower-income households as employment data continued to show negative real wage growth.

Despite the reported increase in appetite, companies did not appear to have confidence in consumption forecasts with mega-chains such as Walmart and Home Depot seeing deep cuts in their stock prices last week.

In the opinion of Peter Schiff, CEO and chief global strategist of Euro Pacific Capital, the Fed’s rate hikes have been largely ineffective as credit borrowing stayed elevated, and savings rates remain extremely low.

Consumer price index (CPI)

The PCE data followed the disappointing CPI print which came in at 6.4% YoY, barely nudging lower from the 6.5% in December 2022.

The high number was on the back of stubbornly-sticky shelter costs and the surge in food expenses.

Egg prices rose an incredible 71% YoY in January.

To add to the gloom, Schiff believes that the CPI is grossly underestimating current inflation, stating,

I think if you double the official CPI, that’s probably close to accurate.

Economists from ShadowStats commented on this perceived divergence, writing,

Anecdotal evidence and occasional surveys have indicated that the general public believes inflation is running well above official reporting…growing difference in perception versus reality primarily is due to changes made over decades as to how the CPI is calculated and defined by the government.  Specifically, changes made to the definition of the CPI and related methodology in recent decades have reflected theoretical constructs offered by academia that have little relevance to the real-world use of the CPI by the general public.

Revisions

The underlying concern that the CPI may be under-reported, whether due to methodological changes or survey issues, was only further fuelled by the high degree of revisions to the data in past months, dispelling any deflationary notions.

Producer Price Index (PPI)

The PPI was higher by 6.0% YoY in January, reaching its lowest level since March 2021.

However, this too was only slightly lower than the 6.2% recorded in December 2022 and much higher than expectations of 5.4%.  

Core PPI came in at 0.5% for the month, above expectations as well.

Inflation outlook

For nearly a year, the Fed has tightened at an accelerated pace which has included four consecutive hikes of 75 bps.

In response, the CPI and other indicators reacted by easing significantly.

However, the degree of contribution of tightening in this equation is uncertain given that at the time supply disruptions cornered policymakers from every angle, including the Russia-Ukraine war, skyrocketing fossil fuel prices, the onset of the summer driving season in the US and shipping delays.

Schiff noted,

…(easing inflation) was bound to happen when you had a rate as high as 9.1% (in June 2022)…

Since the Fed downshifted rates to 25 bps well before the January inflation prints, we may well see a rebound play out in the very next month.

It appears that monetary authorities may be having a harder time than anticipated in shaking off the history of prolonged ultra-low interest rates, sustained quantitative easing, and huge expansionary fiscal policy amid the pandemic.

To add to the mix, the administration is looking to increase the debt ceiling even further, while Andy Schectman, President of Miles Franklin Precious Metals, fears,

And if they all (other countries) start to dump dollars, and I think it would happen quickly, you would have a tsunami of inflation hitting the shores of the West.

For additional context, readers may check out this piece on the trends favouring de-dollarization.

The short-lived deflationary trend may be coming to a close, with inflation to be spurred on by the Fed’s decision to ease rate hikes and expectations of additional spending by the government.

The rising PPI is of particular concern, given that it often acts as a reliable leading indicator of inflation in the broader system.

If reports shift higher in the coming month, equities are bound to head lower as markets will fear additional tightening.