Are Jerome Powell and I Looking at the Same Data?

Key takeaways

Sticky service inflation

Powell indicated that service inflation would be a reason for interest rates to go higher than expected.

Improving numbers

Headline inflation, personal consumption, money supply, wages, and other indicators are improving.

While watching Federal Reserve Chair Jerome Powell’s conversation with Carlyle Group Chairman David Rubenstein at the Economic Club in Washington, DC on Tuesday, I was left wondering if Powell and I are looking at the same data. Notably, Powell said, “The disinflationary process has begun but has a long way to go.” He acknowledged the improvements in goods inflation but suggested that service inflation remains sticky. He indicated that would likely be a reason for interest rates to go higher. Far be it from me to question a Fed chair. However, this is starting to feel like the other side of the “transitory” coin, with the Fed being late to acknowledge what the market seems to already know. In late 2021, they didn’t acknowledge that inflation had been let out. Now, it’s that inflation is falling rapidly.

The Fed is data dependent, so let’s look at some numbers.

• Headline inflation: The six-month percent change in the Consumer Price Index has fallen to 0.94% from a peak of 5.43% in June. It stands well below the long-term average of 1.75%.¹
• Core inflation: The rate of change in the core Personal Consumption Expenditure, the Fed’s preferred measure of inflation, is below the Fed Funds Rate.²
• Money supply: M2 money supply growth, which has historically led inflation by roughly 12-18 months, has grown by 0% over the past year.³
• Wages: Wages are slowing, notwithstanding the strong January nonfarm payroll report. Average hourly earnings are up 4.4% over the past year, down from a peak of 5.9% in March 2022.⁴
• Rents: The survey of tightness in apartment markets from the National Multifamily Housing Council moved to record-low levels. This explains the recent slowing in rental price increases and suggests it should continue.⁵
• Goods: The Retailers: Inventories to Sales Ratio, which fell to a historically low 1.08 during the worst of the supply-chain challenges, has climbed to 1.24 as sales moderate and inventories climb.⁶
• Expectations: The one-year inflation breakeven (the difference between the 1-year US Treasury rate and the yield on the one-year US Treasury Inflation Breakeven Security) is at 2.36%, down from over 6% last year.⁷

The risk to the recent market recovery trade is that the Fed commits to overtightening. That’s the Paul Volcker playbook from the early 1980s. Back then, it ended in a recession in 1981 and a near-term retracement of much of the gains that the market had made after inflation peaked.⁸ Despite it all, investors who had invested when inflation peaked in March 1980 were well rewarded over the subsequent three years and beyond. The S&P 500® Index advanced by 75% from the inflation peak in March 1980 through March 1983.⁹

My conclusion is that in the near term, we ignore the Fed at our own peril, but we take comfort in the inflation data moving in our favor. The Fed’s hawkish stance and any market volatility that arises from it are likely to be, well, transitory.

Footnotes

• 1Source: US Bureau of Labor Statistics, 12/31/22.
• 2Sources: US Bureau of Economic Analysis and US Federal Reserve, 12/31/22. 
• 3Source: US Federal Reserve, 1/31/23. M2 is coins and notes in circulation plus short-term deposits in banks and certain money market funds.
• 4Source: US Bureau of Labor Statistics, 1/31/235
• 5Source: National Multifamily Housing Council, 1/31/23.
• 6Source: US Census Bureau, 12/31/22.
• 7Source: Bloomberg L.P., 2/7/23.
• 8Source of recession: National Bureau of Economic Research. Source of market returns: Bloomberg L.P., as represented by the S&P 500 Index, a market-cap-weighted index of the largest companies in the US. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results.
• 9Source: Bloomberg L.P. S&P 500 Index is a market-cap-weighted index of the largest companies in the US. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results.

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Originally Posted February 8, 2023

Are Jerome Powell and I looking at the same data? by Invesco US

Header image: Xiongmao/Adobe Stock

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

All investing involves risk, including the risk of loss.

Past performance does not guarantee future results.

Investments cannot be made directly in an index.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Disinflation, a slowing in the rate of price inflation, describes instances when the inflation rate has reduced marginally over the short term.

The Consumer Price Index (CPI) measures change in consumer prices as determined by the US Bureau of Labor Statistics.

The Personal Consumption Expenditures Price Index is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Retailers: Inventories to Sales Ratios show the relationship of the end-of-month values of inventory to the monthly sales. These ratios can be looked at as indications of the number of months of inventory that are on hand in relation to the sales for a month. For example, a ratio of 2.5 would indicate that the retail stores have enough merchandise on hand to cover two and a half months of sales.

Tightening is a monetary policy used by central banks to normalize balance sheets.

The S&P 500 Index is a market-capitalization-weighted index of the 500 largest domestic US stocks.

The opinions referenced above are those of the author as of Feb. 8, 2023. These comments should not be construed as recommendations but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.