December 1, 2023
Inflation eased and incoming data disappointed – Fed appears adamant

The headline CPI reading of no inflation (0.0%) in October surprised financial markets (but not us). This led to a rally in the bond market as yields (especially in the longer term) fell. Then the PPI (Producer Price Index) for October appeared with a negative number (-0.5%), and this is usually a harbinger of what is to come in future CPI readings.

Economists agree that monetary policy operates with long and variable time lags – most think at least a year. If this is the case, recent rate hikes will continue to weigh on economic activity through 2024, at a time when that activity is already slowing.

In our view, it is possible that we have exited this inflation cycle and may be headed for deflation unless the Fed moves to lower rates soon. That appears very unlikely at this point, as Fed Board members have made clear in recent public announcements. At present, the market is estimating the first rate cut in the meeting on June 12-13 next year. Our view is that depending on the upcoming economic data, it is more likely to happen in the May 1-2 meeting or perhaps even earlier.

As we have discussed in several blogs, the data for the shelter component of the CPI (35% weighting) is significantly lagging. Without the haven component (i.e., the other 65% of the index), the monthly change would have been -0.1% (i.e., mild deflation) and the year-to-date number on which the Fed rests would have been +1.5%, now that the Fed Below the 2% holy grail. Substituting the -1.5% year-over-year rent change of apartment inventories for the shelter component would yield a backward-looking headline CPI somewhat closer to +0.5% on a year-over-year basis rather than the current 3.2% headline number. . So, it’s no surprise why economists at the Federal Reserve Bank of San Francisco think headline CPI inflation will reach 0% by the end of 2024 (see chart at the top of this blog).

The table shows the quarterly path of headline CPI to the end of 2024 under the assumptions of 0.0%, +0.1%, +0.2%, and -0.1%. (We abandoned the -0.1% assumption because we believe it is possible if the Fed actually keeps interest rates “higher for a long time.”)

The Fed’s backward lowering CPI target rate of 2% will be breached next March under the 0.0% inflation assumption. This will reach around +0.1% in June under estimates. We see the +0.2% assumption as a worst-case scenario, in which inflation would fall to 2.4% by Dec ’24. Furthermore, we believe there is a strong possibility that low-level deflation could occur, depending on the length and depth of the coming recession. Thus, the -0.1% assumption column.

As noted above, and reinforcing our view that inflation is melting, PPI (prices paid by businesses) fell -0.5% in October, also reversing a +0.4% increase in September. is higher, which has been revised up by +0.5%. (We note here that most economic series have declined in recent revisions.) The PPI for consumer prices, a sub-index of the general PPI, and a very good predictor of upcoming CPI releases, was -0.6% in October. Shown in form. And a modest +1.4% on a year-over-year basis. While everyone is still focusing on “inflation”, recent data shows a definite trend towards “deflation”, i.e., a fall in prices.

data consolidation

There are other data that support this view.

  • Retail sales fell -0.1% in October, significantly less than September’s +0.9% growth. Once again, this matches a common thesis that “excess savings” have been exhausted by Uncle Sam’s “free money” gifts. Declines were led by automobiles (-1.0%), furniture/appliances (-0.9%; negative for four consecutive months), and building materials (-0.3% from September, and -5.6% from a year earlier). Johnson Redbook same-store sales fell throughout October, making the August-September same-store sales growth appear to be an anomaly (see chart).
  • Additionally, major retailers such as Walmart
    , and Home Depot look at select consumers and low/low discretionary spending. For example, Home Depot saw a decline in same-store sales (-3.1%) in Q3, with traffic (-2.4%) and revenue down (-3.0%) from year-ago levels. Walmart, Macy’s Dollar General
    , and Dick’s Sporting Goods says consumers are slowing spending on non-essentials. Walmart CEO Doug McMillon said on his earnings call: “We could be dealing with a period of deflation in the coming months…” [Note: We aren’t the only one’s who see the possibility of deflation! Walmart always has its act together!]
  • The result appears to be that expectations for the holiday shopping period have been lowered. Challenger Gray & Christmas says seasonal hiring is “the lowest it has been in a decade,” 40% less than posted hiring in 2021. and FedEx
    Anticipating lower volume of package deliveries for the holiday season.
  • China’s economy continues to struggle, especially in their real estate sector. And while their reported numbers still show positive growth, it is much slower than “normal.” The key to the world is their exports, causing their export prices to fall (right side of the chart below), thus causing deflationary exports to their trading partners. Presumably, falling export prices are, at least partly, due to slowing demand.
  • The left side of the chart shows the NY Fed’s Global Supply Chain Stress Index, which reached a record low (data dating back to the mid-1990s), at a reading of -1.74 standard deviations. This index value is no surprise as global freight rates have declined and Moller-Maersk, the world’s largest container shipper, is in the process of reducing staff by -10,000. Therefore, it is no surprise that the Cass Freight Index has declined, now approaching its low point in the GFC recession. We think this index will set a new low soon.
  • With hostilities in the Middle East and the ongoing war in Ukraine and without the operation of the Nordstream pipeline from Russia to Europe, prices in commodity markets continue to trend downward, including oil prices. The closing price of WTI crude on September 26 was $93.68/bbl. It closed at $75.84 on Friday (November 17), down -19%. Its lowest level was $72.90 on Wednesday (November 15), which was the highest decline of >-22%. And we have seen that in China, the world’s largest oil importer, refineries have cut production, which is a sure sign of the slowing economy there. Falling gasoline prices will go a long way in reducing inflation expectations.
  • Apart from the exaggerated statement of inflation by the headline CPI due to the rent issue, examination of some of the key components of that CPI should lead the reader to believe that the inflation epidemic is almost over. Following are the price changes from September to October:
  1. Oil: -19% (26 September to 17 November)
  2. Energy: -2.5% (demand destruction)
  3. Airline fares: -0.9%
  4. Used cars: -0.8%
  5. Equipment: -1.2%
  6. Restaurants: -0.9%
  7. Hotel: -2.9%
  8. Movement/Freight: -3.1% (negative for three consecutive months)

This last item is worth a comment: Part of the negative price change in moving/freight in the month of October was likely due to slower home sales (nobody moving) as people with lower mortgage rates “repurchased” their own homes. There are prisoners!”


While many businesses are trying to retain their employees after labor shortages over the past few years, costs can only be cut so far; Ultimately, if business is slowing down, layoffs are bound to happen. Earlier we noted that the world’s largest container shipper, Moller-Maersk, had announced layoffs of -10,000. And none other than Citibank has recently announced a -10% reduction in its workforce. It seems like there are some major layoffs announced every week this Q4. Initial jobless claims have recently begun to rise (+231K week of November 11 vs. +218K week of November 4 and +211K equivalent week in 2022). With the large layoffs recently announced, we expect initial unemployment claims to continue to rise.

Ongoing claims data is of equal or greater importance. These increased +32K in the latest week (Nov 11), and are up +411K from a year ago and +160K ​​in Q4 alone. This is a symptom of the fact that jobs have become much more difficult to find than a year ago.


Housing is the key to GDP growth. As discussed in previous blogs, there are record numbers of new apartments under construction, and supply increases as they come online. As a result, we are seeing both falling rents and rising vacancy rates. The chart, produced by Rosenberg Research, shows a combination of existing and new home sales. Watch for steep declines in 2020 and 2021, especially as the Fed raises interest rates in early 2022.

Existing home sales have declined significantly due to rising mortgage rates, and major home builders are moving to reduce their offerings to keep product at lower prices as housing affordability is lower than it has been since the 1980s. Was seen. This is reinforced by the University of Michigan’s Sentiment Index Terms of buying a house, Note on the chart that the historical low has been broken. In fact, a University of Michigan survey of home buying plans fell sharply in November, to a score of 33 compared to 44 in October, which is equal to the lowest reading recorded in the survey’s history (going back to the 1950s). ! Then, since most homeowners have mortgage rates in the 3% range, even a sideways move is unaffordable with mortgage rates closer to 8%. As a result, it appears that housing has entered a recession.


Industrial production (IP) fell -0.6% in October after a revised decline in September (+0.3% to +0.1%). The manufacturing component contracted by -0.7% (compared to +0.2% in September, revised from +0.4%). Pre-auto (strike), manufacturing was flat.

The Philly Fed’s manufacturing index was -5.9 in November, slightly better than October’s -9.0 reading, but now showing contraction for three consecutive months. Almost all sub-indexes were lower, especially the work week (-11.4 November vs -4.3 October).

The Kansas City Fed’s manufacturing index stood at -2 in November while it stood at -8 in October. Every major sub-index was also negative in this report, including employment, workweek, production, backlog and capex. There is no doubt in our minds that manufacturing is already in a recession.

foreign trade

Another sign of easing inflation appears in foreign trade data. In October, import prices fell -0.8% and are -2.0% lower than a year earlier. Excluding oil imports, import prices still fell in October (-0.2% and -1.1% lower than Oct ’22). Export prices also fell (-1.1% in October alone and -4.9% compared to a year earlier). In the developed world, as mentioned above, China is struggling, the UK economy is flat as a pancake, while Germany and Japan both appear to have entered recession.

final thoughts

Obviously, inflation is melting. October CPI showed 0% inflation, and PPI for October was negative. Eliminating the existing upward bias in the shelter component of the CPI and substituting current rental data would yield a headline CPI under 1%.

Somehow, despite the Fed’s own economists forecasting a sharp decline in inflation in 2024, the Fed appears bent on continuing the war they have already won, and in doing so, risking a deep recession. Is. We believe it is now too late to avoid a recession, the only question is its depth and duration. Moving rates into a less restrictive zone and increasingly into the 2.5% “neutral” zone would go a long way in mitigating the ill effects of the coming recession. But we don’t think the Fed sees these realities.

After almost two years of falling bond prices as the Fed raised rates at the fastest pace in history, it is now clear that they are done hiking, as deflation is now visible and we may even be looking at the possibility of deflation. are looking. Because recessions typically accompany a decline in corporate earnings, it now appears that the battered bond market will shine in 2024.

(Joshua Barron and Eugene Hoover contributed to this blog.)

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