Unless you really don’t follow the markets, you know the Federal Open Market Committee (FOMC) met this past week and didn’t actually do anything. By that, I mean it did not raise or lower the target overnight lending rate. This was what investors had expected, no surprises.
What was a surprise was how ‘dovish’ the Fed seemed regarding inflation moving into next year. So much so, the members of the FOMC apparently think there might be the need for 3 rate cuts next year. Couple this with favorable comments from Fed Chairman Jay Powell and, voila, you could almost hear the markets breathe a sigh of relief.
Basically, unless something really unforeseen happens, and I mean beyond the pale, the Fed is done with this tightening cycle. Over. Kaput. By definition, the next move has to be a rate cut. But when? That is the $64,000 question.
If the current Fed Funds futures market on the Chicago Mercantile Exchange is accurate, the odds are the first cut will happen by the 3/20/2024 meeting. Further, it appears investors believe the Fed will ultimately slash the overnight target upwards of 150 basis points next year, not the 75 that the Fed has telegraphed.
Oh boy. The markets and the economy love cheap money, and the cheaper the better. But is inflation really dead? Is the Fed taking its foot off the brake too soon?
Not surprisingly, the answer is “it depends.”
Make no bones about it. Things simply cost more than they did. The most recent whammy at the Norris house was the annual reset of our car insurance. My goodness. I will be driving a bicycle to work if they jack up the premiums like that again next year. Then, there is the grocery store.
This past Tuesday, the Bureau of Labor Statistics (BLS) released the Consumer Price Index (CPI) for November. If it is to be believed, overall inflation increased 0.1% last month. More importantly, for the purposes of this newsletter, ‘food at home’ climbed 0.1% and ‘food away from home’ surged 0.4%.
I would like to know where they are shopping.
Not so long ago, I truthfully didn’t think too much about the prices at the grocery. Don’t get me wrong, I wasn’t throwing money around. However, if I needed asparagus, I bought asparagus. If I wanted chicken breasts, I grabbed a package. The same could be said for just about any item in the store. If I felt I needed it, it went in the basket.
These days, not so much.
For example, the other day I went to the store and wanted some tomatoes. Between salads, sandwiches and sauces, we probably go through more than the average family. Although I know they are out of season here in Alabama, the prices for all types made me wish I was a tomato farmer or something. So much so, I only put 2 in the basket, as opposed to the usual 3-4.
While that is just one small anecdote, if I am changing my behavior, what about the average American consumer? After all, I have been far more blessed than most. There has to be a fair amount of pain ‘out there,’ regardless of the official economic data.
Those people pointing to the official data and suggesting wages are going up faster than the rate of the inflation probably aren’t struggling to put food on the table.
As Fed Chairman Jay Powell has said: “The burdens of high inflation fall heaviest on those who are least able to bear them.” A report from the Dallas Fed clearly spelled this out in a report this past January which showed a huge gap in how inflation impacts low and high income earners. While that statement isn’t terribly intuitive, the results were somewhat eye-opening.
Consider this.
- According to the data in the report, fully 42% of households earning $75-100K (the proverbial middle class), found inflation stressful in 2021. This prior to the worst of it.
- Conversely, only 17% of households making in excess of $250K reported being stressed.
Of particular concern were rents and, you guessed it, food.
Perhaps not surprisingly, a disproportionate number of Americans believe the ‘direction of the country is on the wrong track.’ According to a composite of polls various sources conducted between 11/3-12/12, only 25.2% of Americans felt the country was moving in the ‘right direction.’ Conversely, 67.8% felt it was on the ‘wrong track.’
I suppose the other 7% didn’t understand the question, or were too busy eating $4/lb. tomatoes to answer.
To be sure, the polls cover more topics than just inflation. However, it seems intuitive people would be more sanguine about the passing scene if they felt more secure in their finances. It is weird how that seems to work.
This has a point.
The Rate of Inflation
The rate of inflation, the pace at which prices are rising, is growing at a decreasing rate. That doesn’t mean prices are coming down in general. Further, it certainly doesn’t mean prices are coming down for those things which you ordinarily purchase. For instance, if you don’t eat beef, what difference does it make that it went down in price last month, or so they reported? More importantly to you, the price for ‘cereals and bakery products’ climbed 0.5%, and eggs went through the roof at a 2.2% clip.
This begs the question: If prices aren’t coming down but the rate of inflation is coming down, is the Fed doing the right thing telegraphing rate cuts in the upcoming year?
From a purely monetary policy point of view, the answer is probably yes, with an emphasis on probably.
Counterintuitively, a few rate cuts might actually even cause the CPI to fall even faster.
You see, one of the stickier line items in the data has been the ‘owner’s equivalent rent of residences.’ As mortgage rates have risen, it has become far more expensive to purchase a house. Because of this, landlords have had pricing power or the ability to raise rents. As a result, a large percent of the overall equation, let’s call it 25% for cocktail party purposes, has continued to climb faster than the price of finished goods.
As such, as rates fall, homes should become more affordable, which means rental rates should start to ease. Voila. I would find it hard to imagine at least one member of the FOMC hasn’t contemplated this.
Therefore, I would submit the following.
The Fed now believes it has enough control on the price of goods to focus on the price of services. Unfortunately, a lack of semi-skilled workers will keep pressure on wages until businesses ultimately replace the need for them with technology. This will happen just as sure as I am about the sun rising in the East tomorrow.
Interestingly, the higher cost of money is probably hindering business owners’ ability to raise funds for that purpose. As a result, they are forced to continue to look for slightly higher priced workers because they are still more efficient than debt at 8-9%, or higher. Therefore, lower borrowing costs could actually be the impetus for employers to start investing in more efficient means of generating capacity than extra workers.
Couple this with the impact lower rates will have on rents and, again counterintuitively, inflation could or should continue to come down in 2024. The price of goods will remain higher than anyone would like. However, the cost of services could actually come down in the equation as debt becomes more affordable.
That might not be what they teach in business school. However, it is exactly what is going to happen.
In the end, asset prices had a great week thanks to the Federal Reserve. Interestingly, far from being soft on inflation, it is very clearly signaling a new way of driving down the rate of growth in the few sectors it can control with the cost of money.
As a famous felon might say: “it’s a good thing.”
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.
John Norris
Chief Economist
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, 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.