The Market Today
Growing Support at the Fed for Patience as Core Inflation Remains Stable
by Craig Dismuke, Dudley Carter
Consumer Prices Rise in December on Firmer Medical Care Prices, Moderating Housing Rents: December’s CPI inflation report reflected the impact of lower oil prices with overall energy prices down 3.7% MoM, dragging headline inflation down 0.1% for the month. Oil prices dropped from $76.41 per barrel in October to the 2018-low of $42.53 on December 24th, a 44% decline. The decline is likely to weigh on energy components in consumer prices for months, eventually feeding into the core components, albeit with a smaller impact. For December, core consumer prices, excluding food and energy, remained firm. Core prices gained 0.21% MoM (+0.18% 12M avg.) keeping the YoY rate steady at 2.2%. The important categories of owners’ equivalent rent and medical care prices were mixed. OER pulled back slightly after November’s strong reading, rising just 0.23% MoM (+0.26% 12M avg). Medical care prices rose a solid 0.29% MoM (+0.17% 12M avg) on another strong month for hospital and related services (+0.41% MoM). Auto prices were a bit weaker in December with new car prices rising just 0.01% and used car prices falling 0.18%. Elsewhere, there was particular strength in fruits and vegetable prices (+1.7% MoM), lodging away from home (+2.7% MoM), home gas and electricity (+1.8% MoM), infant clothing (+1.2% MoM), and educational books and supplies (+1.1% MoM). Additionally, recreation goods rose 0.6% MoM, the biggest monthly jump since 1996. Overall, the December CPI inflation report shows stable core inflation, moderating pressure from rents, continued gains in medical care prices, and some volatility for the headline figures as the drop in oil prices works through the data.
Yesterday – Stock Recovered from Retail Slump, Powell’s Balance Sheet Remark to Match Longest Positive Push Since February: Stocks closed near the highs of the day, but exerted a lot of effort to secure modest gains on Thursday. The major indices tumbled at the open after a couple of major U.S. retailers reported weaker-than-expected holiday sales activity. Macy’s and Kohl’s both said activity around the holidays was weaker than expected, forcing investors to try and figure out whether the disappointments were company-specific issues or symptoms of a more concerning trend of consumers pulling back. Shares of Macy’s tanked 17.7% while Kohl’s share price slipped 4.8%, leaving their peer group down nearly 3% on the day. But sentiment outside that space gradually recovered before pulling back as Powell again addressed the future size of the balance sheet (more below). The big three indices, however, managed to shake of the angst and move up again to close between 0.4% and 0.5% on the day. The S&P 500’s positive finish was its fifth in a row, matching the longest run since February. Treasury yields also spent most of the day moving higher and steeper, with the 2-year yield ending up 2.3 bps at 2.58% while the 10-year yield rose 3.2 bps to 2.74%, the highest since December 27. The biggest move, however, was made by the Long Bond which moved up 6.0 bps to 3.06% after a re-opening auction tailed by more than 1 bp with a below-average bid-to-cover ratio.
Overnight – Yields Fall As Equities Pause, European Data Misses, U.S. Inflation Matches Estimates: Ahead of this morning’s CPI inflation report, which will carry a greater importance for monetary policy in 2019 as discussed in our outlook webinar on Wednesday (more below), both equity futures and Treasury yields had pulled back. Asian stocks rose Friday following hard-fought gains Thursday in the U.S. but the major European indices were mostly lower. An unexpectedly-large decline in Japanese household spending seems fitting for a narrative of slowing global growth. November’s activity slowed more than expected and marked the eighth YoY decline for 2018. In Europe, industrial production in November also slid more than expected in Spain, Italy, and the U.K., reinforcing concerns that uncertainty around trade and Brexit has had broad impacts on economic activity. The British Pound, however, was a top performing currency Friday on a report that certain cabinet ministers speculated Brexit would be delayed past the March 29 deadline. Downing Street quickly dismissed the report. Before the BLS inflation data was released, the 2-year and 10-year yields had both dipped roughly 3.8 bps. Those moves were mostly intact after inflation matched estimates.
Powell Sticks with Patience But Sees Balance Sheet “Substantially Smaller”: Powell again preached a message of patient policy Thursday at The Economic Club of Washington. Similar to last Friday, he addressed disparate signals from the economic data and financial markets, saying “I think we’re actually in a good place, …particularly with inflation low and under control we have the ability to be patient and watch patiently and carefully as we see the economy evolve and figure out which of these two narratives is going to be the story of 2019.” When pressed to reconcile patience with the two rate increases planned in the dot plot for 2019, he clarified “There is no such plan. We don’t actually vote on a path or plan for interest rates, …two rate increases was the median. And it was conditional on a very strong outlook for 2019, an outlook which may still happen. But the good thing is we’re in a place where we can be patient and flexible, …we’re waiting and watching.” But the stock market stumbled again when he responded to another balance sheet question. Powell said, “We wanted to have the balance sheet return to a more normal level, which is a level that is no larger than it needs to be for us to conduct monetary policy, …don’t know the exact level, …it’ll be substantially smaller than it is now, …but nowhere near what it was before [QE].”
Other Fed Officials Show Little Urgency for the Next Rate Increases: St. Louis Fed President Bullard (voter) said that while economic activity has surprised to the upside, inflation has remained muted and as a result “The FOMC should moderate its normalization campaign given that the yield curve is getting close to inversion, …A significant and sustained inversion of the Treasury yield curve would be a bearish signal for the U.S. economy.” He described the December rate hike as “a bit of an overreach,” saying he’s “concerned we’re on the precipice of a policy mistake.” Chicago’s Charles Evans (voter) recycled a sentence about patience from his Wednesday’s remarks in a speech on Thursday, adding “We can easily wait six months to kind of look at the data and see how things come in.” Kashkari from Minneapolis, who doesn’t vote again until 2020, said that despite the surprisingly strong labor market, there may still be additional slack to be absorbed. Fed Vice Chair Clarida said that despite solid economic growth, “it’s not yet clear that inflation has moved back to 2 percent on a sustainable basis.” He also said the global growth concerns and market volatility “represent crosswinds to the U.S. economy” which if “sustained, appropriate forward-looking monetary policy should seek to offset.” Considering December’s hike placed the top end of the overnight range at the bottom-end estimate of the neutral range, he said that, “With inflation muted, I believe that the Committee can afford to be patient as we see how the data evolve.”
Vining Sparks 2019 Outlook Webinar: Vining Sparks hosted our 2019 Economic Outlook Webinar discussing recent market volatility, solid U.S. economic fundamentals, the importance of inflation trends, the growing risks the economy faces in 2019, and ultimately what the impact could be to Fed policy and interest rates. Click here to view the replay and here for a copy of the slides used.