What a difference a week and one economic report make! Things HAD been going somewhat swimmingly in September. Unfortunately, on Tuesday, the Bureau of Labor Statistics (BLS) drained the pool with a disappointing Consumer Price Index (CPI) report. Just leave it to a group of bureaucrats to ruin everyone’s good time. Am I right?
I won’t go into all of the gory details of the inflation report. Suffice it to say, prices remain higher than anyone would like, especially for food. This despite the recent swoon in energy prices.
This takes us the questions we have been asking for a while: 1) how much longer will prices continue to go up at the recent feverish pace, and; 2) will the Federal Reserve kill the economy in its zeal to kill inflation? These are the same questions we have been asking since the start of the year. Frankly, it is getting a little monotonous.
So much so, it begs the question why did everyone freak out this past week when nothing much has really changed? Why did investors go from ebullient to despondent in the proverbial drop of a hat? It’s not us, it’s them. Right?
You could make a very decent argument that is indeed the case.
As I have written here and said in public, seemingly ad nauseam, inflation will start to moderate in the foreseeable future. This past month’s numbers were a little surprising. However, they don’t negate the reality of the situation. This being it would be a neat trick for the 12-month CPI to continue clicking along north of 8.0% by the end of the year.
Undoubtedly, stranger things have happened in the past and will happen in the future. However, you can throw a pie in my face on the TV if inflation is running at the current pace by the end of December. Check back with me during the second week of January 2023.
I feel confident in this prediction for a number of quantifiable reasons. First, the Commodity Research Bureau BLS/US Spot All Commodities Index (CRB) has fallen like a rock since the end of April. This proxy for commodities, or inputs, closed on 9/15/2022 at 569.10. This is a significant drop from the recent high of 644.07 on 5/4/2022. Believe it or not, it is also less than where it was at the end of 2021, at 578.31.
Second, and I feel like a broken record, the money supply (as defined by M2) is growing at a 1.76% annualized rate YTD through July. That is well less than the historical average. It also begs the following: how long can the CPI grow at 8% when the money supply is growing less than 2%? To be sure, it can do so for a while. However, it won’t be able to do so forever. It is just math.
Third, at the end of August, the US dollar was very strong relative to other major currencies. In fact, as defined by the DXY index, it is stronger than it has been since May 2002. Obviously, that is other 2 decades. This is important because, historically, there is an inverse correlation between the strength of the dollar and consumer prices. The reason being twofold: 1) a strong dollar makes imports less expensive for US consumers, and; 2) since most commodities are bought and sold in US dollars, the stronger it is the fewer it will take to buy, say, a barrel of crude oil.
Fourth, the last two monthly observations for the CPI have been 0.1% and 0.0%. Conversely, there were 0.4%, 0.9%, 0.7%, and 0.6% for the last four months of 2021. So, between now and the end of the year, we will be taking larger monthly numbers out of the trailing 12-month calculation. More than likely, we will be replacing them with much lower ones. If we assume the CPI grows at an average of 0.2% per month for the last four months of 2022, the CPI will end up at 6.3% for the year. Obviously, that is significantly lower than 8.3% the BLS reported this past Tuesday.
It really is ‘just math.’
Fifth, simply put, the yield curve is mostly already inverted. This should slow down the extension of credit in the economy. If past is prologue, and it often is, this will reduce aggregate demand. Going back to you Econ 101 class: what happens to prices when demand goes down? Assuming supply doesn’t drop more quickly, and there is always a lag, prices should go down.
Sixth, everyone expects the Federal Reserve to continue raising the overnight lending target between now and the end of the year. That hasn’t changed. Further, the markets are anticipating the Fed will start cutting rated next year, likely by the end of the summer. That too hasn’t changed. What has changed is the estimated peak ‘implied’ overnight rate. That has increased roughly 37 basis points this week.
So, all of this angst over 37 basis points? Is that how the Federal Reserve is going to kill the economy? An additional 37 basis points? Hey, for some very clever sorts on Wall Street slinging money around, 37 basis points can mean umpteen dollars. But for almost everybody, 37 basis points will NOT be the difference between the penthouse and the outhouse. I cannot stress that enough.
Whew.
To paraphrase Yogi Berra, this topic feels like déjà vu all over again. For good reason too! I have written extensively on the subject(s) and made the same arguments. I guess you can say the more things change, the more they stay the same. Or, even a broken watch is right twice a day. There are any number of appropriate clichés.
This takes me back to the first paragraph. Again, what a difference a week and one economic report make! But what has really changed other than investor psyche? Frankly, I would argue not much of anything has changed. That is what makes this week’s market action that much more frustrating. However, it, too, will eventually end. It always does.
Not even the bureaucrats can stop that.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
Chief Economist & Broken Record Player
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.