Look for another inflation report this week. This time–on March 31–it’s the Federal Reserve’s favorite inflation model, the Personal Consumption Expenditure (PCE) index. And, there’s potential trouble in this report–if projections from the Cleveland Federal Reserve Bank’s Inflation NowCast are accurate.
Goldilocks is just about the only thing keeping the current stock market afloat in the face of a storm of worry from a banking crisis, to stubbornly high inflation, and signs of a cooling economy. The Goldilocks story says, Don’t worry about all that. The Federal Reserve is about to pivot on interest rates. At its May 3 meeting, the Federal Reserve Open Market Committee might raise interest rates by 25 basis points but that will be the last interest rate increase. And then the Fed will move to start cutting interest rates in the second half of the year with financial markets pricing in as much as 200 basis points of cuts by the end of 2024. And all this will happen, too, without a recession, as the Fed engineers a successful soft landing of the economy and a significant slowdown in inflation.
If you believe that, you should be buying stocks. I don’t believe it. And more importantly, the bond market doesn’t believe it.
The European Central Bank raised its benchmark short-term interest rate by another 50 basis points today. The bank said that the European banking system has strong capital and liquidity positions in spite of problems at Credit Suisse that led that bank to borrow $54 billion from the ECB yesterday. Fighting inflation remains the bank’s top priority.
U.S. prices at the wholesale level, the producer-price index, fell in February from January, the Bureau of Labor Statistics reported this morning. The producer-price index fell 0.1% in February from January after a 0.3% month-to-month increase in January. Will that be enough so that the Fed has an argument for NOT raising interest rates next week?
Today’s topic is The Fed’s Impending Disaster. The CPI inflation numbers for February looked good from an annual perspective–headline at 6% and core at 5.5%–but if you look month to month, inflation ticked up slightly. In the big picture, inflation is lower, but we’re not seeing it fall at the speed the Fed would hope. The Fed wants to get inflation down to 2% and we’re currently around 5.5% core inflation–a long way off. If you look at those numbers alone, you’d expect the Fed to continue raising their rates. This is what the market was expecting just last week, projecting a 25-50 basis point increase for the March 22 meeting. The thing that puts the Fed between a rock and hard place is the Silicon Valley Bank collapse and additional banking stressors that could lead to more disasters inside the Treasury market. In February the FDIC said that insured banks had about $620 billion in undeclared losses. With $23 trillion in the banking system, $620 billion is less than 10% overall, but if it’s concentrated in certain areas, it could cause more blow-ups. We don’t know if we’ll see any big Wall Street banks go down, like Lehman Brothers back in 2008, but I am watching Credit Suisse closely, especially after the big hit to its share price this morning, March 15. Essentially, the rapid hikes in interest rates have put strains on the banking industry and the Fed will have to decide whether they will continue raising rates to fight inflation, or stop in favor of supporting banks while inflation is still high at 5.5%.
Tomorrow’s CPI inflation report for February will show whether the Federal Reserve faces a very difficult task in bringing down inflation without crashing the economy (and/or the banking system) or whether the job is simply impossible. Right now economists are pointing toward impossible. The annual inflation rate is likely to have come down in February from January but the month-to-month trend is likely to be flat. Which means that inflation has stopped declining with the annual rate well above the Fed’s 2% target rate.
This is going to take me a while to get all five steps posted. The market situation is very complicated right now and the appropriate solutions are very specific. I’m going to start with the short-term moves you need to be making NOW and then gradually extend my recommendations to cover the entire next five months. I’ve now posted Steps #1, #2, and #3
The Personal Consumption Expenditures index, the Federal Reserve’s preferred inflation gauge, rose in January at its fastest pace since June. Consumer prices rose 0.6% from December to January, up sharply from a 0.2% increase from November to December, the Commerce Department reported on Friday, February 24. Year-over-year prices rose at a 5.4% rate, up from a 5.3% annual race in December. Core inflation, which excludes volatile energy and food prices, rose 0.6% from December, up from a 0.4% rise in December from Movember. Year-over-year core inflation was up 4.7% in January, versus a 4.6% year-over-year rate in December.
Minutes from the Federal Reserve’s February 1 meeting show a central bank anticipating Federal Reserve further increases in interest rates in order to bring inflation down to the Fed’s 2% inflation target. “Participants observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2%, which was likely to take some time,” according to the minutes of the February 1 meeting released today February 22.
Today, February 21, the yield on the 10-year Treasury rose 14 basis points to 3.95%. Other Treasuries dropped in price and showed higher yields as well.
The big event of the week will be Friday’s report on the Personal Consumption Expenditures (PCE) inflation index. This, rather than the CPI, is the inflation measure that the Federal Reserve watches.
The comments come from two of the Federal Reserve’s most hawkish members on the need for higher interest rates to combat inflation, so the remarks aren’t exactly a surprise. Nonetheless, the language does push the envelope on thinking about where the Fed’s interest rate peak for this cycle of interest rate increases might be.
