Low Inflation & No Chance Of A Deep Recession

Low Core Inflation Again

Core inflation would need to rise significantly and stay there for the Fed to raise rates. That likely won’t happen. November CPI report showed more of the same as core inflation hardly moved. Core CPI stayed at 2.3%, while headline CPI increased from 1.8% to 2.1% because of energy inflation. This increase in headline inflation hurt real wage growth, but it’s still positive. 

Production and supervisory real wage growth is still very strong. Low energy inflation helped real wage growth for most of this year as energy inflation was negative every month except April. That’s likely to change because of the easy comps it will face in the next 4 months. If oil spikes because of renewed global growth, real wage growth could go negative.

As you can see from the chart above, most inflation was related to services. Commodities inflation was 0.6%. It is 37.2% of total inflation. Service sector has been driving inflation for the past year as it was 2.9%. That’s what happens when the labor market is tight and we are in a cyclical slowdown. 

If the economy recovers, there could be an issue with headline inflation, but since the Fed reacts to core PCE, it probably won’t hike rates. It takes a lot for core PCE inflation to stay above 2% for a few months. And it hasn’t happened this cycle.

Details Of CPI Report

Energy inflation was -0.6%, but that actually was a big improvement because the comp got easier. Energy inflation was -4.2% in October. It fell from 8.9% to 3.1% last year. In the next 4 months, the comps will all be negative which means energy inflation will turn positive if oil prices don’t crater. I can’t see why oil prices would fall sharply considering the coming cyclical improvement in global growth. 

Food inflation was 2% which means it didn’t impact headline inflation much. Food at home inflation was 1% because of low commodities inflation, while food away from home inflation was 3.2% because leisure and hospitality wage growth has been strong.             

In line with the chart earlier in this article, commodities less food and energy inflation was only 0.1%, while services less energy services inflation was 3%. If commodity prices ever ramp, headline inflation will be an issue. It would be interesting to see if the Fed cares at all about that or just sticks with following core PCE. 

Politically, there is motivation on the left and the right to push the Fed to be more dovish (for different reasons) probably because inflation hasn’t been an issue since the early 1980s. Fed is in great shape because there is low inflation, low unemployment, and there’s low risk of a deep recession. There shouldn't be anything but a light recession occurring at any point in the next few years. 

Once again, medical care services inflation drove core inflation higher. It was 5.1% which matched the cycle high and October’s reading. This means core PCE inflation will stay low. Medical inflation is calculated differently and has a different weight than it does in the CPI report. 

Inflation hawks love to discuss how terrible this is, but even the core CPI report shows low inflation. Plus, the consumer’s long term inflation forecast in the University of Michigan report is at a record low. Finally, shelter inflation stayed at 3.3% and transportation inflation was 0.8%. There wasn’t much doing in this report other than the increase in energy inflation. Hence, it won’t change the Fed’s guidance for no hikes next year.

Recession: Monetary Policy

Some argue that the Fed’s rate hikes in 2018 into an economic slowdown still put the economy at risk of a recession. This argument was supported by the negative business investment in Q2 and Q3; it will likely be negative in Q4. In my view, the Fed’s mistakes in 2018 are old news. 

Fed already corrected them by cutting rates this year. And, Fed is now slightly accommodative. I’m looking for the Fed’s rate cuts and the global cyclical turnaround to help the U.S. economy in 2020. Recession risk in 2H 2019 didn’t end up being realized. It’s not clear how weak the economy was in Q3 and is in Q4, but it’s very clear there wasn’t/isn’t a recession.

Reason There Is Little Risk Of A Major Recession

This expansion has been a huge deleveraging event. The biggest negative catalyst the bears can come up with is that some auto loans were given to risky buyers. That’s nothing like the housing bubble. In fact, auto delinquency rates are already elevated, yet the economy isn’t in terrible shape. There is very little risk of a big recession.

Most likely recession scenario is the economy getting moderately worse than it was in the 3 slowdowns this cycle. The chart below shows all debt to GDP. Even when including all governments (state, local, & federal), debt to GDP is down. Consumer finances are in great shape. 

And the consumer drives 2/3rds of the economy. Even with the decline in profit margins, small businesses are confident and the labor market is strong. Therefore, I don’t see a recession the next year or the next recession being terrible.


Inflation was low again, although, energy inflation dug into real wage growth. Fed definitely won’t hike or cut rates in January regardless of the changes to the FOMC. There is currently a 0% chance of a hike or cut in the next 2 meetings. 

Fed made a mistake by hiking rates into the 2018 slowdown, but that was made up with the cuts this year. 2020 will be helped by those cuts. And economy has deleveraged in this expansion. Also the consumer is in great shape. Even with the decline in margins, firms aren’t firing workers. If they do, there will be a moderate recession. It won’t be nearly as bad as 2008. 

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