November CPI Reveals Inflation Pressures Remain Modest

Dec 12, 2018
House for Rent

Equities were in the midst of a modest recovery yesterday as Monday evening trade talks between US and Chinese officials alleviated some concerns that the  Hauwei CFO’s arrest might be a sticking point to such talks.  That rally, however, turned when the Donald, Chuck and Nancy Show in the Oval Office revealed for all to see the discord for our coming divided government. The presidential threat (promise?) of a government shutdown also didn’t help matters and that led to afternoon selling.  This morning, equities are set to open higher as global stocks are rallying on the US/China trade talk news and apparently ignoring the Oval Office dust-up. Meanwhile, the November CPI report is out this morning and mostly in-line with expectations (more on that below). This is the last bit of inflation news before next week’s FOMC meeting and while it won’t alter the expected rate hike at that meeting, the Fed will be looking for any hint of increasing inflation pressures to inform their 2019 rate hiking projections.  The market is betting that global growth headwinds, geopolitical concerns, and lack of excessive inflation pressure will cut the Fed’s plans for three hikes in 2019 to two or less.


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With the Fed expected to hike the fed funds rate to 2.50% (2.25%-2.50%), next week the Fed would really like to see inflation move decidedly above 2% to give them a key pillar on which to support further rate hikes in 2019. In that regard the CPI results this morning will likely leave the Fed wanting more.  November’s CPI numbers met expectations with core CPI gaining 0.2% month-over-month, matching the prior month, while year-over-year it printed an as-expected 2.2% versus 2.1% in October.  The near-term trend remains moderate as well with the 3-month annualized core CPI rate at 2.1%.   In addition, the Fed’s preferred inflation measure: core PCE tends to trail core CPI by 30bps so the 2.2% core CPI print implies a 1.9% core PCE. Close to the Fed’s 2% benchmark but still below.


We’ve mentioned before that the rate hikes this year were relatively easy to engineer but next year each hike will become successively more difficult as the fed funds rate approaches the lower range of the neutral estimate—currently thought to be 2.50% -3.50%—especially if growth and inflation momentum wanes. The lack of a real move higher in inflation pressure found in this report will only add to the rate-hiking difficulty next year.


Combing through the details of the core CPI number, Owners Equivalent Rent and the other housing-related inputs were the key categories keeping core-inflation at back-to-back 0.2% prints.   Housing expenses (which includes owners equivalent rent) rose 0.3% matching the October gain.  With a nearly 42% weighting in the index housing-related expenses have been driving the core rate increases this year (core CPI ex-shelter was 1.48%YoY).  With housing activity moderating these strong monthly gains seem unlikely to hold.


As for headline CPI the flat 0.0% print matched expectations as the drop in oil and gas prices offset increases in other categories.  The latest CPI release is further confirmation that the expected (hoped for?) late-cycle spike in inflation due to a 50-year low in unemployment remains elusive. The Phillips Curve proponents on the Fed, of which there are many, will have to wait another month to see if demand-pull inflation readings start to appear, because at this point they are not. Even increases in wholesale prices from the recent PPI release appear not to be filtering into retail prices yet and that means profit compression which adds another plank to the peak earnings arguments.


Despite the as expected inflation readings, the levels (both core and overall) hovering just over 2% are keeping real earnings positive but nothing to write home about.  Real Average Hourly Earnings increased 0.8% year-over-year versus 0.6% in October due mostly to the recent decline in YoY CPI from the high-2%’s to low-2% levels. For the month, real average hourly earnings popped 0.3%, as the drop in overall inflation provided the real earnings boost.


While a  +0.8% YoY gain in real spending power is better than the near unchanged levels in prior months, the recent pop has been more to due with receding overall inflation rates  (2.9%June YoY) so expecting a boost in consumer consumption may be fleeting.  That fact, along with inflation not trending materially higher, are two  reasons why rate hikes in 2019 will become more difficult to accomplish. Nominal wage gains that don’t accelerate beyond the current 2.8% to 3.1% YoY trend and inflation pressures remaining  docile doesn’t provide strong reasons to continue with quarterly rate hikes into 2019. 


The recent equity volatility over trade, Brexit, and other gathering geo-political risks further complicates the case for additional rate hikes in 2019.  Thus, it will be interesting, following the FOMC meeting next week, the updated economic and rate projections. Right now we expect September’s three-hikes-in-2019-scenario to get cut to two hikes with one more rate hike forecast in 2020. That would bring forecasted rate hikes to the long-run rate of 3.00%. The market, however, is betting on less than that with barely 12bps in hikes in 2019 based on futures, and that minimal hike gets cut in 2020,  again, per fed funds futures.  So the Fed and the market still have differences to reconcile and it may start at next week’s FOMC meeting.




Market Update  Core CPI and PCE Trending Lower


As we move into 2019, the Fed will become much more data dependent on rate decisions versus this year. The main reason for a more deliberative Fed is the fed funds rate is approaching neutral (estimated between 2.5%-3.5%), which is the estimated rate that is neither accommodative nor restrictive. In 2019, the Fed will be watching trends in GDP growth, unemployment and inflation to dictate rate decisions. Core CPI and PCE reflect the broadest view of consumer-level inflation and both have been trending lower of late. If the trend continues into the first quarter of 2019 it will certainly complicate a rate-hiking decision in March.

Core CPI and PCE Trending Lower



Agency Indications Agency Indications — FNMA / FHLMC Callable Rates


Agency Indications — FNMA / FHLMC Callable Rates



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