Inflationary Trends Emerging
Last Friday’s economic calendar provided investors with some potentially meaningful insight into the timeline for the Federal Reserve’s next move on interest rates. On Friday morning, the Bureau of Labor Statistics released the PPI-FD data for December. If investors were expecting a lull in the velocity of inflation acceleration heading into year-end, they were disappointed.
Inflation, as measured by the PPI-FD, for the month of December was in line with expectations. The month-to-month top line reading was 0.3%, matching consensus. However, the year-to-year change from December of 2015 was 1.6%, meaningfully hotter than the 1.3% that was called for by Bloomberg consensus. Less food and energy, the two most volatile components of the basket, the month-to-month change was 0.2% versus consensus calling for 0.1%. In short, the inflation readings measured at the producer level were in-line or slightly hotter than expected.
The unrevised PPI-FD in November of 2015 was -1.6%. Considering that this latest reading was 1.6%, that does reflect a healthy, though stubbornly still below target, rate of inflation. Very importantly, December’s reading followed September’s 0.0%, October’s 0.7% and November’s reading of 0.8%. There is justification to believe a trend has materialized. The Fed’s raise of 25 bps last month could well act to support this trend in spite of the fear that some have that any monetary tightening could choke off the yet tenuous embers of incremental inflationary acceleration.
Consumers voting with their pocketbooks and enthusiasm
One of the factors that could well contribute to the concept that the Fed’s monetary move in December will complement current inflationary trend as opposed to extinguishing it, is consumer sentiment. Last Friday, we received the preliminary University of Michigan Consumer Sentiment reading for the month of January (98.1). Though January’s reading was one tick below December’s 98.2, it is holding at cycle highs. The reading for January of 2013, four years ago, was 71.3. Even as recently as October of 2016, the reading was only 88.5.
A very clear correlation between consumer sentiment and consumer spending been a long standing fact of economic life. On Friday we received the Retail Sales report for December — arguably, the most important month of the year for the economy from a consumer spending stand point. Including the data registered in the autos sales vertical, retail sales for the month were 0.6% — very solid, though one tick below Bloomberg consensus which was calling for 0.7%.
A potential concern reflected in this data comes from the fact that if auto sales are removed, consumer spending was a less robust 0.2%. As if to underscore this concern, department store sales for the month actually fell 0.2%. The most recent data is rather tepid relative to the 12-month high of 1.3% registered in May, 2016. One theme that may explain the department store weakness being posted in recent months comes from the ongoing growth of online shopping. This is a variable worth keeping a close eye on.
Toward full employment
In the broader economic landscape, the national unemployment rate is close to its cycle low at 4.7%, as of the December reading released on January 6. Though there are plenty of arguments that could be made to undermine the veracity of the rate, it does speak to multi-year trend and a significant move lower since the depths of the financial crisis. Is the labor force participation rate too low at 62.7%? Yes, but it could be argued that we are seeing a leveling-off in the participation rate given the readings we have received over the past six months. Are wage gains still too modest? Yes, but we did see a 0.4% tick higher in Average Hourly Earnings (month-to-month) component of the last Employment Report.
The economic landscape at the outset of 2017 speaks to modest growth, incremental gains in inflation, cycle highs for consumer sentiment and small business optimism. Stable energy prices, continued expansion in the housing sector of the economy and the prospects of a leaner regulatory regime in Washington all should lead to a constructive narrative for rates. If these trends remain intact through Q1, my expectations are that a good argument could be made for a 25 basis point move by the Fed on rates sometime in Q2.
Peter C. Kenny
Senior Market Strategist
Global Markets Advisory Group