On Wednesday, the Bureau of Economic Analysis (BEA) informed the world the U.S. economy grew at a 1.6% annualized rate during the 1st quarter of 2024. This was considerably less than the median estimate in the Bloomberg analysts’ survey, 2.5%. However, the underlying data was a little better than the headline number. Regardless, no matter how you dice and slice the data, it was a mediocre report.
Then, on Friday, the BEA announced the PCE deflator, the Federal Reserve’s preferred inflation gauge, increased at a 0.3% clip. The so-called core number, excluding supposedly volatile food and energy, also increased 0.3%. As a result, the trailing 12-month product for both were 2.7% and 2.8% respectively.
The Fed’s stated inflation target is 2.0% for the core.
As such, inflation is still churning a little hotter than the Fed would like, and is unfortunately, is not moving in the right direction.
So, where does this leave us? Somewhat sticky inflation and modest economic growth? When I was a kid, the experts called this stagflation. If you aren’t familiar with the term, you will be by the end of the campaign season. There is no way on God’s green earth the Republicans aren’t going to hammer on this in order to recapture 1600 Pennsylvania Avenue. None.
Of course, this assumes it continues, which it probably will to some degree.
A few weeks ago, I gave a number of different reasons why inflation isn’t going to fall the way anyone would like. This included diminishing returns from globalization, drought in the Midwest, higher wages and decreased worker productivity, to name a few. However, I left out one extremely important one, math.
You see, any 12-month economic inflation number is nothing more than the product of the previous 12 months. For instance, if the previous 3-month CPI observations were 0.3%, 0.3%, and 0.4%, math would be 1.003 * 1.003 *1.004 = 1.010033. To convert that into a percent, you would simply subtract 1 from the product and then multiply by 100. So, in this little example, the trailing 3-month CPI would be 1.0033%.
Voila. Exciting stuff, huh?
Intuitively, any 12-month product will go down in value when you replace higher numbers with lower ones. Assume the monthly data points in our example were 0.2%, 0.2% and 0.3%. What would be the trailing 3-month CPI if this were the case? If you answered 0.7016%, give yourself a pat on the back.
With this in mind, the Fed has a pretty tough road ahead if it is insistent on getting that core PCE deflator down to 2.0%.
Consider the last 12 months of data points for that series.
| April 2023 | 0.31 |
| May 2023 | 0.29 |
| June 2023 | 0.17 |
| July 2023 | 0.12 |
| August 2023 | 0.10 |
| September 2023 | 0.33 |
| October 2023 | 0.10 |
| November 2023 | 0.09 |
| December 2023 | 0.10 |
| January | 0.50 |
| February 2024 | 0.27 |
| March 2024 | 0.32 |
Other than the fact that inflation seems to be accelerating, what else strikes you? At least as it pertains to calculating a 12-month product? Let me spare you the trouble. There aren’t a lot of small numbers to replace moving forward. With the exception of last September, the core PCE deflator was lower than 0.2% every month from June through the end of the year.
This means, in order for the 12-month product to go DOWN, the monthly number has to be lower than it was 12 months prior. For example, the June 2024 monthly data point will have to be less than 0.17%. July will have to be lower than 0.12%, and August, you guessed it will have to be 0.09% or less. You get the picture.
If NOT, the 12-month core PCE deflator will either remain around 2.8% or actually increase.
While this time could be different, the Federal Reserve ordinarily doesn’t start slashing the overnight rate when inflation is accelerating.
Not surprisingly, expectations for Fed rate cuts have largely evaporated.
After the December 2023 FOMC meeting, the futures market started pricing in the possibility of up to seven 25 basis point (0.25) rate cuts this calendar year. That would have been a blessing for anyone with a balance on some revolving debt or looking to purchase a home.
Thanks to persnickety, there is that word again, inflation data coupled with stronger-than-they-should-be labor numbers, investors are now betting on 1, maybe 2, rate cuts by the end of January 2025. What’s more, the first one, if there is one, likely won’t happen until September, at the earliest.
I have been doing this for a pretty long time, and I can’t remember another similar reversal of thought surrounding Fed policy. If not a reversal, perhaps “a throwing of hands in the air” is a better way of putting it.
But what does this mean for investors? I mean, the hope of cheaper money has been largely driving the markets for the last couple of quarters. Can the rally continue without it?
The easy answer is the rally can continue until Doomsday, as long as corporate America can continue to meaningfully increase profits indefinitely. Since that isn’t a probably case scenario, investors should expect, shall we say, a breather from the wealth creation in the not-so-distant future. That doesn’t mean financial market collapse or mayonnaise sandwiches for Thanksgiving.
It simply means this summer proves to be a rollercoaster ride for investors. You can blame stagflation if you want. Or you can blame the Fed. Shoot, blame Joe Biden, Donald Trump and the rest of the lot in Washington. Blame whoever you want, it won’t change anything unless inflation goes down and unemployment goes up.
Yep, in so many ways, this week, the BEA told investors to turn off CNBC, Bloomberg News, Fox Business and other business media outlets, at least until the end of summer.
Have a great weekend.
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 well 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.