The Ghost of Inflation Reappears
By Randall W. Forsyth
Photo: iStockphoto
“And things are going up/ and up and up and up/ And my check remains the same/ That’s why I got the blues/ Got those inflation blues.”
Wall Street seems to be singing along with B.B. King’s lament, although it isn’t feeling the squeeze like the hoi polloi. The moneyed crowd worries that the gravy train of cheap money from the Federal Reserve will come to an end. Main Street, however, soon may be feeling B.B.’s blues, as its denizens see any uptick in their paychecks eaten up by the increased cost of living.
“Inflation Blues” dates back to the bad old days of stagflation, that ugly term from an ugly time decades ago of simultaneously rising prices and high unemployment. And while we’re far from those Carter-era readings that sent the so-called Misery Index—consisting of inflation plus the jobless rate—soaring, recent data belie the bullishness that, until a couple of weeks ago, prevailed on Wall Street and Main Street alike.
The consumer-price index jumped 0.5% in January, the Bureau of Labor Statistics reported last week. The core rate that conveniently strips out food and energy prices rose 0.3%. Both of those readings were above forecasts, but also flattered by the conventions of rounding to one decimal place. Before rounding, the overall CPI was up 0.54%, while the core measure was up 0.349%. With just a few hundredths more of a percentage point (that’s basis points to financial folks), the total jump would have been 0.6%, while the core increase would have come in at 0.4%.
Leaving aside the month-to-month squiggles, the real story is that inflation is closing in on the Fed’s 2% target. Former Fed Chair Janet Yellen had been nonplussed by inflation’s failure to move up to the central bank’s standard for “price stability,” and was cautious in increasing the Fed’s key policy interest rate, which currently is targeted in the 1.25%-to-1.50% range. Low interest rates, of course, have been an important prop to the stock market and to asset prices in general.
Yellen’s recently installed successor, Jerome Powell, won’t have the same confusion about falling short on inflation. The stock market’s recent paroxysm of volatility was set off a couple of weeks ago when the BLS showed that average hourly earnings in January were up 2.9% from the level a year earlier. The consumer-price data also indicated an acceleration in price trends over shorter periods. For instance, the overall CPI increased at a 4.4% annual clip over the latest three months, lifting its year-over-year rate to 2.1%, according to the calculations from Michael Lewis’ Free Market Inc. consultancy. Core CPI, meanwhile, increased at a 2.9% yearly pace in the past three months, and was 1.8% above its year-earlier reading.
In other words, the much-bruited 2.9% annual rise in hourly earnings reported for January is just keeping ahead of inflation. But there also was a drop last month in hours worked, which meant total earnings actually were down 0.1% in a month when pay packets supposedly were increasing at last for working men and women. (Could those hours lost be a result of the widely reported flu outbreak? JPMorgan economist Daniel Silver considered that possibility. He wrote in a report that the flu season could have affected the workweek, but the impact would seem to be small.)
In any case, the effects of the flu and any seasonal aberrations in the recent numbers will pass.
And even if January’s rise in the CPI was overstated, a real cyclical uptrend is under way.
Those rising prices, moreover, have been eating away at pay gains and have forced consumers to dip further into already meager savings to maintain their spending.
Looking more deeply at the January jump in CPI shows definite trends, according to Steven Blitz, chief U.S. economist at TS Lombard. Deflation in the prices of consumer goods we like to buy is ending; the rate of increase in the cost of things we have to buy either is rising, as for food and energy, or remains high, as for services or rent.
Goods inflation has been held down since the mid-1990s by increased low-cost imports, technology, or slowing spending by “aging baby boomers” (or should that be “aged”?). The dollar’s weakness is boosting import prices (up 1% in January and 3.6% from its level a year earlier), which should pass through to consumer prices this year and into the next.
As for technology, the magic of hedonic adjustments produces deflation, although the real world sees mobile phones costing a grand or more. Meanwhile, the cellphone price wars of last year lowered the inflation measures back then and, in turn, will boost the year-over-year increases in price gauges in 2018. (To paraphrase the song from a few years ago, it’s all about that base.)
Consumers’ paychecks had been keeping up with rising rents and services costs, while prices of goods have been falling, Blitz continues. “With goods prices set to rise and rent showing no signs of slowing down (in the aggregate), consumer finances are set to be squeezed further,” he writes.
That vise has been visible for some time. To keep up their spending, Americans cut their savings to just 2.6% of income in the fourth quarter.
But that’s not a new phenomenon, according to Stephanie Pomboy of MacroMavens. Nondiscretionary outlays—for food, energy, housing, and medical expenses—have accounted for 55% of the increases in household spending over the past two years. During that same period, savings have been “pillaged,” she writes in a recent missive to clients. “The ineluctable conclusion is that the decline in saving is occurring out of necessity, not choice.”
One cost of living that doesn’t get counted directly is debt service. In another note, Pomboy points out that the cost of paying back debt jumped by $62 billion through the third quarter—which predates the most recent rise in interest rates. Given the increase in rates since then and the Fed hikes likely this year, she conservatively estimates an additional $75 billion jump in debt service in 2018. “That alone would wipe out nearly all of the $80-to-$100 billion boost to growth forecast from the tax cuts,” she observes.
As for drag from the fiscal side, President Donald Trump’s suggestion last week of a 25-cent-per-gallon tax would wipe out 60% of the benefit of the tax cuts to individuals, according to Strategas’ Washington team lead by Daniel Clifton. No wonder this trial balloon was made of lead.
It’s too early to tell, but the unexpected drop of 0.3% in January retail sales was consistent with consumers being squeezed by higher prices. Don’t pin too much on one month, since retail sales are among the data series most prone to revision; December’s preliminary 0.4% increase was revised away to no change, for example. And sales of more costly gasoline provided a big boost; gas sales grew at a 23% annual rate in the past three months, while overall sales expanded at a 2.1% annual clip.
Inflation is depicted by optimists as a sign of the economy’s robustness, which will justify both higher stock prices and higher interest rates. On the latter score, the New York Fed’s Underlying Inflation Gauge rose to 3% in its latest reading, half again the central bank’s inflation target.
If inflation is sapping consumers’ spending power, even after employment gains and tax cuts, it could be seen as a harbinger of diminishing strength, especially as borrowing costs climb.
SO, TO CONTINUE THE song lyrics theme, last week wasn’t the end of the world as we know it. Depending on which index you cite, stocks had their best week since Nov. 11, 2016, with the Dow Jones Industrial Average up 4.25%; or since Jan. 4, 2013, with the Standard & Poor’s 500 index up 4.3%; or since Dec. 2, 2011, with the Nasdaq Composite up 5.31%.
More to the point, last week’s rebound sprang the market from the so-called correction, as the S&P 500 halved its drop from its Jan. 26 peak to 4.90% by week’s end. The real question is why the equity market pulled out of its nose dive. None of the fundamental reasons for the correction had changed.
If anything, the worries about inflation were confirmed by the aforementioned CPI and New York Fed data, which makes another quarter-point hike in the federal-funds rate a 100% certainty at the March 20-21 Federal Open Market Committee meeting, according to Bloomberg’s analysis. The odds of a second hike this year, in September, and a third, in December, were solidly better than even money, after having wavered during the stock market’s slide the previous week.
The plunge was so powerful that it set up for a spring back, comments Doug Ramsey, chief investment officer at the Leuthold Group. But that doesn’t imply that the selling is over, he adds in an email.
There was no real sign of panic in the selloff, outside of speculators who had shorted the Cboe Volatility Index (or certain quarters of the financial media), which typically indicates that retreats are overdone. Surges in other pessimism indicators, such as put/call ratio in options or swings in timing-oriented mutual funds or exchange-traded funds, also were absent.
Bulls’ demises typically are preceded by a period of narrowing participation of at least three to four months, and more typically twice that, he continues. “The latest high, which was only three weeks ago, wasn’t accompanied by the usual weakness in breadth, small-caps, and cyclicals—market signals which indicate that Fed tightening has really begun to bite,” Ramsey adds.
That process still lies ahead, according to him. But he also first sees a renewed rally—starting from lower levels. While the bull market isn’t over, he concludes, neither is the correction.
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