Inflation Won’t Cause The Fed To Hike Rates

Inflation Estimates Fall

Inflation estimates for 2019 were much higher 6 months ago than they are now. Economists see the writing on the wall. Inflation won’t be a problem in 2019, and the Fed definitely won’t raise rates. Economists didn’t see the slowdown coming and they thought rising nominal wage growth would generate inflation. 

Phillips curve is broken as wage growth has been strong without inflation. Fed doesn’t need to hike rates and workers are seeing real wage gains.

It is a Goldilocks economy for workers. Personally, I’m confused by how shelter CPI increased from 3.2% to 3.4% even though house prices have been increasing at a much slower rate recently. Ignore shelter CPI when doing your analysis of the housing market. I think price growth coming down and real wage going up have been enough to improve the housing market this spring. MBA purchase index’s yearly growth rate has increased for 4 straight weeks.  

The chart below shows JP Morgan’s probability distribution calculation of core PCE inflation using various government and non-government sources. As you can see, most guesses are for core PCE inflation to be between 1.5% and 2% for the June 2019 meeting. 

Inflation - Fed won’t hike rates with core inflation below its target and the economy in a slowdown

Even if the consumer is in solid shape. The distribution of estimates gets wider as we go out further in the future. About one quarter of respondents think core PCE will be less than 1.5% from September 2019 to March 2020.

February PCE report will come out on March 29th. That’s after the March 20th Fed meeting, so that report won’t impact guidance. The Fed definitely has enough data to decide to not hike rates in March, to state hikes will remain on hold for as long as the data stays weak, and to end QT in the next few months. 

Interestingly, personal income growth in January was boosted sharply by Social Security and Medicare. Social Security and Medicare outlays were up 6.7% and 9.1% year over year. They accounted for 17% of the growth in gross personal income and 10% of gross personal income.

Inflation - Strong Durable Goods Orders

January durable goods orders report was solid as core capital goods orders recovered from December. 

As you can see from the chart below, monthly new orders were up 0.4% which beat estimates for -0.6%. Consensus was so bearish because headline growth was 1.3% in December. Ex-transportation monthly growth was -0.1% which missed the consensus for 0.1%. December had 0.3% growth.

Core capital goods growth was 0.8% which beat estimates for 0.1% growth. That’s the reason this report was good. December’s growth was revised from -0.7% to -0.9%, so the comp was easy. Core capital goods yearly growth improved from 2.1% to 4.1%. I cautioned the bears against focusing on the negative December monthly growth reading, while ignoring the positive yearly growth. The December report wasn’t good, but no recession was indicated. At the trough of the last slowdown, year over year growth was -8.7%; that wasn’t even a recession.

Machinery orders drove core capital goods up as monthly growth was 1.4% which followed declines of 0.6% and 2%. The comp was easy, but it’s still better than another decline. Orders for electrical equipment, computers, and communication equipment also had solid gains after weakness in the prior two months. Orders for vehicles fell 1% after rising 2% in December. This supports the narrative that the auto industry is in pain. 

In February, light weight vehicle sales, which consist of autos and light trucks, fell to 16.532 million. That was the weakest reading since August 2017 which was suppressed by a hurricane. Besides that month, sales were the weakest since February 2015. This is going to hit GDP growth.

Inflation - Orders for commercial aircrafts were up 16% after increasing 36% and 4.5% in the prior two months. 

Aircraft orders being volatile is the main reason we can’t only look at overall new orders. I’m interested to see how Boeing’s issue with its new planes affects this data point.  Defense aircrafts were also up. 

Inventories were up 0.4% which is a negative when combined with the 0.5% decline in total shipments. Inventory to shipments ratio increased from 1.6 to 1.62. Unfilled orders increased 0.1%.

This durable goods orders report and the solid construction report pushed the Atlanta Fed’s Nowcast estimate for Q1 GDP growth up to 0.4% from 0.2%. Estimate for real gross private domestic investment increased from -2.9% to -2.4%. Because the construction report was helped so much by public spending, the estimate for government expenditures rose from 1.7% to 2.5%.

Inflation - Jobless Claims Increase Slightly

For the past few months, jobless claims have signaled the labor market is softening slightly. The report from the week of March 9th supports this thesis as claims increased from 223,000 to 229,000. 

To be clear, this modest weakness isn’t consistent with the job creation of just 20,000 that was seen in the BLS report. The 4 week average fell from 226,250 to 223,750. That’s the 3rdstraight week of declines. The 4 week average is tracking slightly lower than February, implying monthly job creation will be better. However, it’s still too early to tell. It’s way too early to tell if a recession is coming soon. 

As you can see from the chart below, initial claims have been fluctuating around the flatline for yearly growth.

Inflation - Conclusion

The slowdown doesn’t look to be getting worse as January hard data reports improved from December. However, estimates for Q1 GDP growth are still modest. 

CNBC rapid update shows the median expectation is for 1.4% growth, I expect the February BLS report to be revised higher. March’s report should show above 100,000 jobs created. The great stock market performance in 2019 not only implies the economy recovered from December, but also that growth will solid in the 2nd half of 2019. 

It remains to be seen if that projection is accurate. 

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