Inflation Data Hits Hard - A Big Shift In The Making
CPI inflation data hit this morning and the number increased on a month-over-month basis more than expected dampening all hopes of interest rate increases in the near future - And other market movers.
The Bureau of Labor Statistics released the Consumer Price Index and the number was frothy. Above is one of my primary charts that I use of analysis - The Core CPI year-over-year change versus the Personal Consumption Expenditures year-over-year change. As can be seen, both are trending slightly higher after having moved downward to levels more in line with historical norms. The importance of these two charts is that inflation is a lagging indicator and is driven by consumption. As consumption increases (driven by personal incomes) this puts upward pressure on inflation. Basically, as long as personal incomes are moving higher, and personal expenditures increase on a year-over-year basis, so will inflation pressures. And, while there is typically a delay in inflation data after increases or decreases in incomes & expenditures, the recent upward trends in incomes and expenditures are going to work their way into the economy and from there, the markets are going to react.
Breaking down price increases
The year-over-year inflation rate came in at a frothy 3.801%. - driving upward from 315.419 to 317.088 on the All Items Average for US Cities. The month-over month in crease in inflation came in at 0.529%. Simple math says that if every month over the next 12 months were to hit these levels, year-over-year inflation would be sitting at 6.00%. This is without compounding and the number falls short of what would actually be after 12 months at that rate - it may be more like 7.50%.
The Federal Reserve is targeting a 2.00% annualized inflation rate. Not only is the current rate well above the target rate, but the clear path downward has just been taken out of the equation. The Federal reserve has stated numerous times that they are data dependent and will make adjustments based upon incoming data.
Where as the Fed has penciled in rate cuts for 2024, I have penciled in rate increases - and, have stated this throughout the past several months in many videos on my YouTube Channel. I work on the premise that the economy is a moving target and that the Federal Reserve rarely gets things correct. The Fed pushed interest rates up at one of the fastest clips in history and going from near zero to what they hoped would be the perfect rate level of restrictive interest rates is a near impossibility.
Bond Yields Are Heading Higher
The Fed pushed rate upward all through last year and paused during the summer with a wait-and-see attitude. The market further sold off bonds and pushed yields up to 5.00% on the US 10-Year Treasury, the benchmark investment rate. Supply and demand, along with market anticipation pushed rates back downward well below the 4.00% level. Since then, reality has been creeping back into the market’s perspective.
As long as inflation rates are well-above the Federal Reserve’s target rate, interest rates have no reason to be trickling lower as they did. And, while inflation levels had moderated from the big spike upward, the current interest rate level is not restrictive enough to combat the inflation levels. Keep in mind, inflation is driven by consumption, which consumption is driven by incomes. As income levels increase on a. year-over-year basis, so does consumption, and vice-versa.
What’s driving inflation?
Variables from the latest increases with inflation is being driven by both housing & energy costs. Housing was a substantial driver in the big spike upward in inflation. Unfortunately, housing is a real issue with a big skew in supply and demand. There are a lot of inputs that are out of line and that will likely continue to drive inflation further until these misalignments are corrected.
Further, while interest rates did increase and should have pushed growth downward for incomes & expenditures from a classical stance, there was an outlying variable that did not figure into what is propping up the economy like it has been: The Inflation Reduction Act.
Usually, government activity does not add nor subtract to economic growth on an increasing or decreasing level on a measurable level because government expenditures tend to be fairly straight-line on growth levels. But, extra stimulus does just that: stimulate growth beyond what is normal.
Pressure on the Stock Market
The broad stock market sold off on the news and at the time of this writing with the S&P 500 down some 1.35%. One of the key takeaway for analyzing an economy and projecting the equity markets from that is that any one economic data point does not make an economy: It is a process. Given that, this process has been unfolding continuously and market participants are behind on the curve.
Incomes are rising at an increasing rate and this is driving consumption at an increasing rate. This, in turn, pushes revenues & profits for companies and is doing so at an increasing rate. But, the Federal Reserve is working to contain inflation. The current interest rate level set by the FOMC is not restrictive enough to bring inflation down to the target 2.00% rate in a timely manner.
With the US 10 Year Treasury yield moving upward, stocks will need to move lower as the the comparative benchmark investment rate increases. Stock investors will want a higher yield in comparison to compensate for the increased yield being earned by the a safer investment opportunity. And, as interest rates increase, there will be an overall contraction in economic activity, namely: increases in personal income gains which will translate into decreasing employment and consumption.
Read: The stock market is too high and will move lower.
My 2024 Market Thesis is Playing Out
My market thesis has been consistent since last fall that the economy would expand all throughout 2024. And, my expectation was that the stock market would move upward in the early part of 2024, move through a summertime lull - as it does, but then in the fall blood would start to flow. The thesis was that the market was wrong and that the economy is expanding beyond the level would bring down inflation at a level that would induce the Federal reserve to lower interest rates.
You can see my 2024 Stock Market Analysis video from last year here: