Propelled By Energy and Services, Inflation Accelerates in January

Articles From: IBKR Macroeconomics
Website: IBKR Macroeconomics

By:

Interactive Brokers’ Senior Economist

Markets are moving indecisively this morning as today’s Consumer Price Index report showed that price pressures accelerated in January. This is sour news for market participants and the Federal Reserve  alike, who have recently been cheering signs of “disinflation.” This morning’s data reminds us that lower inflation readings in the recent past don’t guarantee a downward trajectory. Simultaneously, part of January’s inflation reacceleration is driven by the loosening of financial conditions, which calls for the Fed to tighten up its monetary tightening stance and rhetoric. A failure to do so will lead to volatile inflation readings, an adverse reality when looking to achieve 2% inflation.

The market is now expecting the Fed to deliver three more 25 basis point hikes at its next three meetings, which is widening the yield curve inversion to -86 basis points, a level not seen since Fed Chairman Paul Volcker and President Reagan’s administration, more than four decades ago.

Markets were reacting negatively to the news prior to reversing to gains, with the S&P 500 and the Nasdaq indices up 0.3% and 0.6% during morning trading. Bonds yields are spiking at the short-end in a bear-flattening motion: The 2-year is up 7 basis points while the 10-year is up 2 basis points. The market is now expecting the Fed to deliver three more 25 basis point hikes at its next three meetings, which is widening the yield curve inversion to -86 basis points, a level not seen since Fed Chairman Paul Volcker and President Reagan’s administration, more than four decades ago. Higher yields are pushing up the dollar as well, albeit more modestly, up 0.1%. Crude oil is down 2.5% to $78 a barrel, as news of more supply releases from the U.S. Strategic Petroleum Reserve alongside recession fears weigh on prices.

Consumer Prices Accelerate Significantly in January

This morning’s CPI report came in hotter than expected and accelerated from December. Consumer prices rose a whopping 0.5% on a month-over-month (m/m) basis, in-line with expectations and shattering the previous release of 0.1%. The pivotal core category, which excludes food and energy, offered no surprises, rising in-line with expectations and at the same rate as the previous report: 0.4%. On a year-over-year (y/y) basis, consumer prices rose 6.4%, hotter than the 6.2% consensus forecast. When excluding food and energy, core consumer prices rose 5.6% y/y, hotter than the 5.5% anticipated. On balance, accelerating inflation is awful news for the Fed and separately for investors who had transitioned from hoping for a Fed pivot to thinking the inflation battle would be done soon.

Price pressures were broad based with almost every category rising at a pace inconsistent with the Fed’s 2% target. Inflation was led by energy services (utilities), energy (gasoline), medical care commodities, transportation services, apparel, shelter and food at dining establishments featuring lofty price increases of 2.1%, 2%, 1.1%, 0.9%, 0.8%, 0.7% and 0.6% during the month respectively. Food at home and new vehicles also contributed to the increase but at more modest levels. Used cars and trucks and medical care services achieved price declines of -1.9% and -0.7%. Used cars surprised me in this report, because my real-time measures including anecdotal evidence and channel checks from dealerships across the country pointed to an increase. 

While inflation persists, many sectors are hurting from demand destruction. Technology companies have for the most part generated disappointing earnings and revenue while providing weak guidance and announcing large layoffs. Separately, the services industry is being closely watched because it is experiencing persistent inflation. Last night, earnings reports from Palantir Technologies, which provides software for organizations to make decisions, including those related to supply chains, and rental car company Avis provided additional insights into both sectors.

Unlike many tech companies, Palantir Technologies generated impressive fourth quarter growth with revenues climbing 18% to $508.6 and its net profit reached $33.5, making it the company’s first profitable reporting period and exceeding Wall Street expectations. Palantir benefited from increased commercial business, but it also benefited from an expanded U.S. government contract. It also said it expects its revenues to increase this year to between $2.18 billion and $2.23 billion, which would make it the company’s first profitable fiscal year. The company believes its artificial intelligence services will significantly contribute to its growth.

Earnings from Avis, meanwhile, illustrate that the services industry is still enjoying strong growth as businesses and consumers increase traveling with Covid-19 restrictions having been lifted. Its fourth quarter revenues grew 8% y/y and 28% above fourth quarter 2019. Avis Budget Group Chief Executive Officer Joe Ferraro said he expects the trend of strong commercial and consumer demand to extend in the coming months.

In other earnings news, Coca-Cola reported fourth quarter revenues of $10.13 billion compared to $10.2 billion expected by a Refinitiv survey of analysts. Coca-Cola said its revenue increased as a result of the company increasing its prices and also from a more favorable sales mix, or a larger portion of its sales involving products with higher prices. The company has estimated 3% to 5% revenue growth for this year compared to Wall Street expectations of 3.9%.

Investors are likely to see market volatility in the coming days driven by disillusionment over previous optimism that the Fed would back off its higher interest rates for longer-than-expected approach to fighting inflation. On top of that concern, the year-to-date market rally has pumped up equity valuations despite a weakening outlook for corporate earnings.  The combination of expectations for a longer inflation battle, higher valuations and weakening earnings is likely to be a bitter pill for investors. For now, however, momentum is leading to higher prices.

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