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More evidence inflation will force the Fed to raise rates in Q2

By Peter Kenny, chief market strategist for Global Markets Advisory Group and independent market strategist, Kenny & Co. LLC

In last week’s note, I provided detailed economic data to support my thesis that inflationary trends have emerged in the economy in recent months and that as a result, the likelihood of an additional interest rate move by the Federal Reserve in the first half of 2017 is likely. This past week, we received additional economic data that buttressed that call.

For December, the CPI month-to-month (m/m) change was 0.3%, hitting consensus on the nose. However, on a year-over-year (y/y) basis, the top-line CPI was 2.1% versus consensus that was calling for 1.7%. Stripping out the volatile food and energy components of the data, the CPI rate on both a m/m (0.2%) and y/y (2.2%) basis hit consensus.

Even more interesting was the industrial production data we received for the month of December. Production accelerated by m/m 0.8% versus November’s revised reading of -0.7%. Manufacturing meanwhile rose by 0.2% versus November’s -0.1%. Even the capacity utilization rate for December ticked up to 75.5% from November’s 74.9%.

Potentially the most impactful data came from home builders. January’s Housing Market Index (67), which came in two ticks lower than December’s reading of 69, remains at cycle highs. Very importantly, the traffic component of the report came in at 51. This is the first time in over a decade that the traffic reading was over 50 for two consecutive months. In short, the housing market data speaks to a very high level of confidence on the part of home builders—the highest such level since the sub-prime crisis. As I suggested in last week’s note, the Fed’s 25 bps move in December is more likely to support modest consumer inflation than it is to dampen demand. Initial readings for December and January support that thesis.

Additional signs of economic acceleration were also posted last week. The very important Philadelphia Fed’s Business Outlook Survey, a barometer of anticipated mid-Atlantic economic activity, rose to 23.6 from the prior month’s revised reading of 19.7. In July 0f 2016, the reading was a sobering -2.9. Weekly jobless claims came in at a much lower than expected 234K. Consensus was calling for 255K. Housing starts came in at 1.226M versus consensus calling for 1.200M.

Even the EIA Petroleum Status Report provided some lift to markets. Crude WTI inventories slipped to 2.3M barrels versus last week’s 4.1M barrels. Gasoline held even at 5.0M barrels while distillates shrank to 1.0M versus last week’s build of 8.4M barrels.

Not at all unexpectedly, Federal Reserve Chair Janet Yellen (in her talk on January 18) made it clear that the economy was nearing Fed inflation goals. In the process, she reiterated her expectation that markets should anticipate a gradual move higher in rates in 2017. The data we have been highlighting clearly underpins that forecast. Given the trends that are emerging, I would suggest we should expect a move by the Fed at the tail-end of Q2.