PPI Inflation Index Echoes Recent Trend
The recent data for February shows inflation isn’t reaching the same rate it was at in January. It appears analysts got too excited about the reports to start the year. Everyone got on the inflation bandwagon because of low unemployment and the length of this business cycle, but those aren’t great indicators to measure the economy. Ultimately, it’s good news if inflation is moderating. All we need now is for the Fed to hike rates twice this year instead of 3 times and we will have an expansion which is longer than the one in the 1990s. The reality is that inflation isn’t just slowing because of the extra slack in the labor market. The other catalyst is the economic slowdown which I’ll be reviewing in the next few weeks.
For now, let’s look at the February PPI report. As you can see from the chart below, the month over month change in final demand was 0.2%. That was below the 0.4% increase in January. The year over year change increased 0.1% to 2.8%. Excluding food and energy, the month over month increase was 0.2% which was below the previous month’s 0.4% increase. Year over year core PPI growth was 2.5% which was up 0.3% from last month. Overall, this was a stagnant report which didn’t show acceleration like many economists, who extended the trend line, foresaw. For next month, the consensus is for a 0.2% month over month increase in core PPI and a 2.5% year over year increase. There’s nothing in this report which suggests the Fed should get aggressive and raise rates 4 times in 2018.
As a result of this PPI reading, the 10 year bond yield fell again. It declined 2.56 basis points to 2.817%. It is just one basis point above the recent low it made on March 1st. At that point, I became bearish on the 10 year bond because I was only bullish previously because it was oversold. Even though it’s at the same price, I’m not as bearish as I was 2 weeks ago because of the slew of disappointing inflation and economic data. I wouldn’t be surprised if the yield fell to 2.70% in the next few weeks. The 2 year yield increased slightly, meaning the curve flattened. With the 2 year yield at 2.2578%, the difference between the 10 year and 2 year is now 56 basis points. Technically speaking, the next major point of resistance will be 50 basis points. If it falls below that, the yield curve will instantly become the number one story in the financial press. The headlines alone could cause stocks to decline. The chart below shows the yield curve for 3 separate spreads. They are all rapidly flattening which makes it look like 2018 is either 2005 or 2006 in the last business cycle.
The chart above also shows the Fed funds rate creeping up. There is no reason for the Fed to be hawkish when it raises rates next week. If it is a dovish hike, I could see stocks challenging the all-time high. The data released today pushed the Fed funds futures in a modestly dovish direction. The chance of 2 hikes this year is almost the same as 4 hikes. We could see the yield curve steepen if the Fed is hawkish. That will delay the recession by at least a few months.
Terrible Retail Sales Report
The February retail sales results were a disaster. 68 out of 69 economists expected the retail sales growth to be positive, but it was negative. On a month over month basis, retail sales growth was down 0.1%. That missed the consensus by 0.5%. Autos played a big role in the decline as retail sales ex-autos were up 0.2% month over month which missed the estimates by 0.2%. Retail sales excluding autos and gas were up 0.3% which missed estimates by 0.1%. The chart below shows retail sales per capita excluding autos, auto parts, and gas on a year over year basis. As you can see, the sales growth is down from its recent high. It makes it look like the economy is about to enter a cyclical down turn just like I expected based on the ECRI index. I don’t think the economy will fall into a recession in the first half of 2018, but I think it will be weaker than the 2nd half of 2017. There should be some improvement in Q3 2018.
The retail sales report was so bad that it knocked down the Atlanta Fed GDP Now estimate. It now looks like Q1 GDP will be very weak. That’s because January was a good month for the economy, while February wasn’t. The March data might be knocked down by winter storms which means the growth rate could have a zero handle. Bulls will then say we need to throw out the entire report because of the weather. The issue is Q2 might not be much better than Q1.
The chart below shows the effect on the GDP Now forecast which I think should be respected now that 2 months of data are in. The estimate fell from 2.5% to 1.9% because the CPI report and the retail sales report caused the estimate for real personal consumption expenditures growth to decline from 2.2% to 1.4%. It appears Q1 was a bad month for the consumer based on the first two months of data.
Conclusion
While it’s too early to tell exactly what the effects of the Trump tax cuts will be, so far it looks like the only improvement is to earnings growth as the consumer has had a rough first two months of the year. However, there may have been a delay in tax returns which is preventing consumers from getting extra spending money. Three potential negative catalysts which could have hurt February’s results were the government shutdown, the crash in cryptocurrencies, and the correction in stocks. I’m not saying those were major factors which hurt results, but they’re something to keep in mind. The biggest factor which is hurting GDP results is the end of the boom related to the hurricane rebuilding efforts. Weak auto sales look like they will prevent growth from getting to 3%. The blue chip still expects 2.5% growth, but I think that estimate will fall in the coming weeks.
Recent Comments