My Cautious Take on the CPI -- and My Advice for Powell
Let's see what effect, if any, tariffs are having on the consumer price index and how I think the Fed Chair could redeem himself.
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Domestic financial markets breathed an automatic sigh of relief on Tuesday morning after the Bureau of Labor Statistics released its data for July consumer prices. The numbers that hit the tape were largely in line with, or at least close to, what had been expected, at least officially. The initial positive pop across equity index futures markets and moderate rally across the slope of the U.S. Treasury debt security yield curve signal that quite probably, something more inflationary had been, if not expected, at least feared.
Will the early morning rally hold? One thing at a time, my friends, one thing at a time. On Thursday morning, July producer prices, which can run ahead of consumer prices, will cross the tape, followed by July import and export prices on Friday. Then late next week, the Kansas City Fed will hold their annual backyard barbecue, uhm... I mean their economic symposium at Jackson Hole, Wyoming.
The Results
For July, the headline consumer price index -- which is compiled by the Bureau of Labor Statistics, so treat the numbers with a wink and a smile -- showed month-over-month headline consumer-level inflation at growth of 0.2%. This was in line with expectations and a deceleration from June's 0.3% pace. Core CPI printed at monthly growth of 0.3%, which was also in line with consensus view, but was an acceleration from June's 0.2% pace. So far, no real harm, no real foul.
As for the year-over-year data, headline CPI printed at growth of 2.7%, in line with June's 2.7% print and below the 2.8% professional consensus. That was welcome. But Core CPI hit the tape at growth of 3.1%, a bit warmer than the 3% growth we were looking for, and up from 2,9% growth back in June. That was unwelcome. So far, markets seem okay with this though. Let's dig in.
Inside Baseball
The headline data was suppressed overall, thankfully, by energy prices. Gasoline prices were down 2.2% on a monthly basis, while fuel oil prices moved 1.8% higher. Electricity prices, while you might disagree depending on where you live, were 0.1% lower in July. Food prices were weak as well. Prices for food to be prepared at home dropped 0.1%, while food eaten outside of the home printed flat from June.
Going into the core categories, used cars are hot again, as prices increased 0.5%, and in a related matter, transportation services were up 0.8%. Prices for shelter were under control at growth of 0.2%, but medical care services were red hot at growth of 0.8%. Very interestingly, prices for apparel printed at growth of just 0.1%. Now, this is a category that one would think highly susceptible to tariffs. Yet, this category experienced below trend inflation. Hmmm. That may be why markets initially reacted to these numbers in a bullish manner.
Tariff Impacted Areas
So, let's sift through the mountains of data and see what kind of inflation can be blamed on the president's tariffs. This is interesting. Within the apparel industry, prices for men's apparel were down 1.6% month over month, while boy's apparel prices were down 0.6%. Women's apparel was down 0.3%, while girl's apparel was up 0.3%. No impact from tariffs evident there.
However, there is more than the above that goes into the apparel category. Footwear prices were up 1.4% month over month. Clothing prices for infants and toddlers were up 3.3%. Ouch. That hurts young families. Jewelry prices were up 1.1% as well. OK, the category is rather tame, but there are pockets of unwelcome heat.
Let's look at other categories highly susceptible to changes in tariffs. Appliances are mostly imported. Yet, prices for appliances were down a whopping 0.9%. Prices for what the BLS terms as "major" appliances were win 2.2% Whoa. Didn't expect that. Wall Street is loving those numbers. Prices for clocks, lamps and decor were down 1.8%. That's shocking.
One area that is likely already suffering a negative impact from increased tariffs are tools and hardware. Tools and hardware saw prices increase by 1.6% in July. Furniture and bedding supplies were up 0.9% as well.
One thing is clear, the cost of the tariffs implemented are paid by the importer. So far, there is not much pass through to the U.S. consumer that's evident. In fact, something quite the opposite is going on. That would have to result in a contraction in corporate margins for U.S. multinational operations. At the moment, according to FactSet, the S&P 500 is projected to have grown earnings 7.2% for the third quarter on sales growth of 5.8%. Two weeks ago, that was 7.6% earnings growth on 5.5% sales growth, so clearly some margin contraction is already being factored in.
Markets
Since this data was released at 08:30 a.m. ET, over the next 90 minutes or so, we have seen the yield for the U.S. Ten Year Note move slightly higher from 2.9% to 4.3% after dropping at first. At the short end of the curve, the yield paid on the U.S. Three Month T-Bill, which is more reflective of possible changes to monetary policy, has dropped from 4.25% to 4.23%. Equity markets are obviously off to a good start on Tuesday, with all 11 S&P sector SPDR ETFs trading in the green, led by Communication Services XLC, Consumer Discretionaries XLY and the Financials XLF.
Looking at Fed Funds Futures markets trading in Chicago, a 92% probability for a quarter-percentage point rate cut is now being priced in for Sept. 17, up from 82% just ahead of this morning's release. A 61% likelihood is now being priced in for a second quarter point rate cut on Oct. 29, up from 53%. Now there is an even 50% probability seen in this market for a third quarter point rate cut on Dec. 19, as well. As of this morning, just before the release, there was only a 42% likelihood being priced in for a third rate cut this calendar year.
My Thoughts
It's no secret that I have been in favor of putting downward pressure on the short-end of the yield curve for months now. I had believed that Powell was behind and that became quite clear when the July job creation numbers became a three-month period (after revisions) where there had hardly been any job creation at all and in addition to that, labor market data showed a growing devaluation of education by employers.
My math is quite simple. The U.S. Ten-Year Note pays 4.3%. This level is the result of free market price discovery. The U.S. One-Month T-Bill pays 4.33%. Does that make sense to anyone in a growing, not recessionary economy, where inflation is present but not an overwhelming threat? The inversion of this spread obviously suppresses the potential for increased economic activity as to borrow for under a year has become prohibitively expensive. This also hampers the Treasury Department's ability to effectively fund the federal government.
In this environment, if short-term yields are inverted against long-term yields, and we understand that longer-term rates are the product of the free market while shorter-term rates are the product of policy, there is most likely error present. That error is almost certainly driven by policy and not by the free market. Let's be honest. The target range for the Fed Funds Rate of 4.25% to 4.5% is almost certainly a minimum of 1 percentage point too high for this environment. This is suppressed economic growth and put bluntly, is asking for a completely unnecessary crisis. The lack of job creation would just be the beginning. The good thing is that this error is correctable. Next week at Jackson Hole, Powell has an opportunity to rescue his damaged legacy.
At the time of publication, Guifloyle had no position in any security mentioned.
