Another Tame CPI Release Aids Case for Fed Pause

Jan 11, 2019
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The December CPI report is out this morning and is in-line with expectations (more on that below) which will further aid the gathering belief that the Fed will be pausing in the first quarter of 2019.  One of the factors cited by Fed speakers since the December 19th FOMC meeting that a pause may be prudent is the docile inflation readings of late and the latest CPI report builds on that argument. Meanwhile, Chair Powell spoke yesterday afternoon in New York and repeated most of the recent Fed refrain about patience and flexibility in regards to future hikes and being sensitive to signals from the market. The only blip was a comment that the Fed balance sheet should be “substantially smaller than it is now”—something we thought everyone knew. The market eventually regained its footing with equities resuming their pre-Powell rally. The minutes from the December meeting revealed Fed officials discussed exercising more discretion with the balance sheet run-off so Powell’s statement yesterday was eventually taken as a matter-of-fact comment rather than a new policy declaration. Vice Chair Richard Clarida echoed Powell’s patience in a speech last night so just like the mythical phoenix,  the doves have apparently risen from the ashes.


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December’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% also matching the November rate.   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. As we mentioned above, the sanguine nature of the numbers allows the Fed to continue to advance their recent talking points that with no threat of higher inflation on the horizon, the Fed can afford to be patient in regards to the next rate hike.


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 2.2% for the fourth month out of the last five.  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 1.5YoY).  If housing activity continues to moderate the strong monthly gains in the housing-related items seems unlikely to hold.


As for headline CPI, the negative -0.1% print matched expectations as the drop in oil and gas prices offset increases in other categories.  The year-over-year print was an as-expected 1.9% versus 2.2% in November. This CPI release is further confirmation that the previously expected late-cycle spike in inflation due to a 50-year low in unemployment continues to remain elusive. The Phillips Curve proponents on the Fed, of which there are many, have been eating their share of humble pie and this report will be another heaping dose. Also, the increases in wholesale prices from the November PPI release so far are not filtering into retail prices and that means profit compression, which adds another plank to the peak corporate earnings argument and another reason for the Fed to consider pausing.


In another release today, real average earnings gains for consumers could support a case for continued solid spending. With global growth concerns abounding, real average hourly earnings increased 1.1% year-over-year versus 0.8% in November. The drop in overall inflation provided the majority of the boost to real earnings but it’s a boost nonetheless.


The +1.1% YoY gain in real spending power should allow the consumer to continue spending at levels that keep GDP expectations above 2.0%. The question is whether all the market volatility and increasing political gridlock will undermine confidence and force consumers to shut wallets and tighten purse strings. Given the big earnings misses from many brick and mortar retailers during the holiday season consumer willingness to spend in the first quarter may become the big story early in 2019. 


The minutes from the December 19th meeting were released on Wednesday and were more dovish than what Chair Powell characterized at the post-meeting press conference. The minutes discussed five distinct downside risks to the outlook, including a sharper-than-expected decline in global growth; a faster fading of fiscal stimulus, heightened trade tensions, further tightening of financial conditions, and a greater-than-expected negative impact from monetary policy tightening so far. The minutes also revealed that several participants (obviously non-voting officials), argued against the December rate hike. If Chair Powell had mentioned that in the post-meeting press conference it probably could have avoided some of the year-end bloodbath in equities.


In any event, the Fed has adjusted it’s post-meeting comments to better reflect the more cautious tone of the December FOMC meeting as represented in the minutes, and that has the market looking for a pause, at least through March. In fact, while odds of a rate hike this year are off the 0% levels from the beginning of January, odds still are below 20% for a hike anytime this year.  The CPI release from today will only add to the markets’ conviction in that regard.




chart icon  10-Yr Treasury “Death Cross” Signals Lower Yields

In a positive technical sign for those counting on the 38-year bull market continuing in Treasuries, the 10-year Treasury note yield has formed a so-called death cross pattern. This occurs when the 50-day moving average crosses below its 200-day counterpart. While there’s debate among traders about this technical indicator’s relevance to fixed income markets, the graph does illustrate that dating back to 2014, the “death cross” has signaled continued rallies. The most recent cross occurred just as 2019 began, and that just might portend continued yield decreases in the first quarter.


10-Yr Treasury “Death Cross” Signals Lower Yields



chart icon  Market Rates


Market Rates



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