We wrote last week that we had entered the phase of this cycle in which good news for the economy was bad news for the stock and bond markets. The main thrust of this was that the longer the U.S. (or Canadian for that matter) economy continues to show strength in the labor market, the more likely it is that the U.S. Federal Reserve (and the Bank of Canada) will be forced to continue raising interest rates as the only way to cool the economy from a Central Banker’s perspective is to slow demand – and raising rates will eventually slow demand. Anyway, we got some questions on this, so we thought we would put together a quick illustration that outlines the process:
Now, we would caution that this is a bit simplistic as there are other factors that will drive inflation or disinflation such as commodities and currencies and supply shocks (see Covid), but from the Central Bank’s perspective, the graphic basically captures their thinking. Okay, with that out of the way, let’s talk about this week’s inflation data.
First a bit of an aside that is somewhat related to this missive – on Monday, the U.S. “celebrated” Columbus Day. We use quotes because the amount of actual celebration that takes place on Columbus Day is similar to the amount of celebrating Toronto Maple Leaf fans do when the team makes the second round of the playoffs (if you are not sure about this reference, Google “Leafs and second round of playoffs”). Further, the mere fact that Americans “celebrate” Columbus Day at all (as an American, I have license to comment on this) is silly as Columbus never set foot in what is now the United States (although, we would give props to him for missing the massive landmass to his right) and he died basically a disgrace after the general failure of his voyages.
Anyway, we bring up Columbus because the existence of his “celebration” day played a very small role in the week that was. Normally, the U.S. releases the Consumer Price Index (CPI) on the second Wednesday of the month. However, because of the “massive celebrations” that took place on Columbus Day, CPI was delayed until Thursday. CPI has for obvious reasons become the most focused upon data figure we get these days, so let’s segue to a chart of Thursday’s release:
As you can probably guess, this is not very good from the lens of the Federal Reserve. As mentioned above, the food and energy parts are mostly outside the control of the Fed, but the “All Other Items” part, which is what the Fed is trying to bring down rose 0.6% month over month (which annualizes to ~7.2%) and is up 6.6% year-over-year. Now, as we wrote a couple of weeks ago, if we simply got CPI readings of 0.1% or 0.2% month-over-month from here until the middle of next year, headline CPI would drop to below 3% by May/June of 2023. This would occur because we would be replacing very high monthly numbers from late 2021/early 2022 with these new lower numbers. However, at 0.4% for overall CPI and 0.6% for the parts that the Fed can control, we are clearly not there yet.
We remain optimistic that things will get there and, perhaps, faster than people think. Higher interest rates always have somewhat of a lag (you don’t raise them and magically things cool off) and we are likely to enter that “post-lag” zone in the next few months. Demand is clearly slowing for lots of stuff – used cars, apparel, appliances, etc. – while it remains strong for other things – travel, new cars, etc. Most of the things where it remains strong can be directly tied to Covid – travel demand is high because of pent-up demand from ~2-years of not traveling; new car demand is high because there was very little availability of new cars in 2020 and 2021 because of supply chain problems. With supply chain problems largely resolved and pent-up travel demand likely to get absorbed in the coming months, we would not be surprised to see these “stickier” areas follow suit.