Your Retirement Finance Week in Review
Inflation has been rising. Should the Federal Reserve be worried about it?
The Consumer Price Index (CPI) has been rising steadily since early 2015. It recently settled in above 2%, and the headlines announced that the latest 12-month reading was at the highest level since 2011. Some Fed officials, including Chairman Jerome Powell, have said that the combination of economic growth and recent inflation readings mean there’s a strong case for the Fed to continue to raise interest rates and tighten monetary policy.
But a dive into the details of the CPI indicates that we don’t have much to fear from recent inflation trends and it would be better for the Fed to restrain itself.
While the CPI is well above its lows of early 2015, it still is within the range established since the end of the financial crisis and less than the highs of early 2011. The CPI certainly is low in relation to the strength of the labor market and the economy. Normally, when the labor market is this tight, inflation and wage growth are much higher.
Also, the elements of the CPI that usually surge late in the economic cycle aren’t doing so this time. The spurt in inflation in the last 12 months has come from other factors, many of which are short term.
For example, cellphone providers changed their pricing a little over a year ago. Cellphones are a surprisingly large contributor to the CPI, so the price drop put downward pressure on the 12-month CPI reading for a year. With more than 12 months passing since the big drop in cellphone pricing, the lid it put on the CPI is gone. That makes it appear inflation suddenly is rising when the truth is the CPI for the last year was artificially low. Health care expenses have had a similar effect on the CPI.
Likewise, increases in energy and commodities recently pushed the CPI higher. The decline in the dollar in 2017 also added to inflation with a delayed effect. All these effects are likely to be short term. The decline in the dollar, for example, already has reversed.
Housing, which usually is a big boost to inflation late in the economic cycle, has been fairly stable over the last year.
While surveys indicate businesses expect to pay higher compensation in the next year or so, that forecast has been expressed for a while. The expectations haven’t been realized so far. Compensation increases in this business cycle have been very modest. Businesses also report limited ability to pass through cost increases to customers.
The cyclical prices that usually rise sharply late in the economic cycle aren’t doing that now. They’re fairly stable. In the meantime, there are long-term factors that contain price increases. These include technology, global competition and high debt levels.
There don’t seem to be significant upward price pressures across the board. If the Fed tightens monetary policy enough to reverse economic growth, it would have limited tools available to turn things around. That’s why I believe one of the biggest risks to investors remains that the Fed might tighten too much and trigger a recession. There usually is a lag of about two years between changes in Fed policies and the effects on the economy. It could be that the Fed already has tightened enough, but we won’t know that until it’s too late.
The Data
There were several housing reports in the last week, and they were mixed.
The Housing Market Index from the National Association of Home Builders (NAHB) declined to 68 from 70. That’s still a strong number but was well below expectations of 78. The weakest part of the survey was traffic in new home sale centers that came in at the lowest level since November.
The Housing Starts report also was mixed. There was a 5.0% increase in starts. But permits for new construction decreased 4.6%.
Existing home sales declined 0.4% for the month and now are down 3.0% over 12 months. But prices rose 2.7% and are up 4.9% over 12 months.
The FHFA House Price Index increased only 0.1% for the month, compared to expectations of 0.5%. That brings the 12-month price increase to 6.4%. That’s in line with the average of the last few years but below the peak of over 7% reached earlier this year.
Industrial Production generally was negative. The headline number was a 0.1% decline in production, though last month’s number was revised higher to a 0.9% increase from 0.7%. The manufacturing component declined 0.7%, compared to a 0.6% increase last month that was revised higher from 0.5%. To top it off, the key business equipment sector declined 1.1%, reversing what had been a steady increase in business investment.
But the surveys of manufacturing businesses continue to look good.
The Empire State Manufacturing Survey came in at 25.0, compared to 20.1 last month. This was well above expectations and indicates very strong growth.
The Philadelphia Fed Outlook Survey dropped to 19.9 from 34.4. That was taken as good news. The new number still is considered strong growth, while last month’s number was considered unsustainable.
The Index of Leading Economic Indicators increased 0.2% compared to 0.4% last month. That indicates growth over the next six months. Jeffrey Gundlach of DoubleLine Funds likes to point out that there hasn’t been a recession without this index turning negative first.
Consumer Sentiment, as measured by the University of Michigan, rose to 99.3 from 98.0. That’s above expectations, the best level in two months and near the best of the recovery. So far, consumers don’t seem bothered by talk of trade wars and other issues.
New unemployment claims declined by 3,000, bringing the week’s claims down to 218,000. As before, all the numbers are at or near historic lows.
The Markets
The S&P 500 declined 0.30% for the week ended with Wednesday’s close. The Dow Jones Industrial Average dropped 2.12%. The Russell 2000 rose 1.86%. The All-Country World Index lost 1.29%, while emerging market equities tumbled 3.31%.
Long-term treasuries rose 0.53% for the week. Investment-grade bonds fell 0.30%. Treasury Inflation-Protected Securities (TIPS) increased 0.26%. High-yield bonds returned 0.19%.
On the currency front, the dollar gained 1.58%.
Energy-based commodities declined 3.18% for the week, while broader-based commodities fell by 4.20%. Gold lost 2.33%.
Bob’s News & Updates
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