Inflation has a way, like a cataclysmic conflagration, of creating its own weather.
In last week’s Deeper Dive, I described in detail how Jerome Powell’s language indicated he has a strong bias at this point toward getting on with cutting interest rates, which will fuel the inflation that is rekindling already this year. There were quite a few tells during his Q&A after the Fed’s FOMC meeting that indicated Powell is about to make a tragic misstep. Now, today, we add all kinds of news of hotly rising inflation.
Just when he should give another interest-rate douse to inflation and scorching hot financial markets, he seems anxious to relax rates even though he repeatedly says we’re in a strong economy with a strong labor market. That makes no sense when GDP just got revised up higher today unless you put it alongside his recent statements to congress that “there will be bank failures” as a result of the CRE crisis.
One tell in Powell’s talk is particularly concerning. He admitted clearly (at least, twice) that inflation in January was much hotter than the Fed wanted to see and that February didn’t look encouraging either; but then he said he expected the higher inflation in those months would away because he believed it was just due to seasonal factors.
That sounded like his “this inflation is transitory” belief that got us deep into this mess in the first place because it kept him from taking corrective action until inflation was way out of control, and then inflation, of course, continued to climb long after he started to lay out the case for tightening. One could not help but think, “Here we go again.”
So to test Powell’s guiding wish (for that is all it is), let’s look at the inflation realities carried in just today’s news.
The flames are rising everywhere
First, we have a story about initial jobless claims still hovering at record lows. In fact, non-seasonally adjusted claims just dropped lower. Continuing claims rose for awhile last year, but have been flatlining for the last two quarters.
We all know a tight labor market, regardless of whether it is tight due to strong demand for workers or due to a greatly diminished labor force, is inflationary. My longtime claim has been that this broken labor market will not give Powell a break. Unemployment will not start to take down wage inflation until Powell has tightened long enough to break something major; and if he starts loosening financial conditions when labor is already tight, stimulating the economy to run hotter, wage inflation will grow more intense. So, he’s trapped.
Powell has taken comfort for some time in the fact that rents were going down, which would eventually show up in the various inflation indices he claimed. Another article today says that rents just grew for the first time in about two quarters this month. If that continues, it will take awhile to price through the indices; but it means more upward pressure on the overall inflation rate down the road that will make inflation stickier for longer.
Thus, one of Powell’s big areas of comfort is now looking like it may put in the upturn that many other areas of inflation have put in over the past six months, which eventually showed up in the year-on-year numbers and annualized numbers in January and February as I’ve warned those monthly upticks would do. Housing is a major component in the CPI and PCE inflation indices.
In fact, this new upturn is likely to hold for quite a few months:
“During the colder months of the year … the rental market tends to be cool,” said Jacob Channel, a senior economist at LendingTree. “As we get closer and closer to summer, we start to see rent prices increase in more places.”
Since rent started rising before winter even ended, it’s hard to imagine it won’t go up all of spring and most of summer.
Resurgent corporate profits are, ironically, a big indicator of inflation, too. That is because inflation gave corporations the cover they needed to justify price increases. So, during the worst periods of inflation that were attributed to rising producer prices and rising commodities costs, corporate profits went up at their steepest rate. That’s profits, not prices. If profits are rising more rapidly than they have in years, even as prices are rising more rapidly than they have in years, then the rise in prices is not just to pass along increased costs. Otherwise, prices would rise, and profits would hold:
Here is a picture of corporate profiteering (price gouging, if you will) off of inflation:
That is one heck of a mountain of extra profits, which mean price increases above cost increases. In fact, it wasn’t just profits that rose but profit margins. As you can see, when the Fed was winning the inflation fight, the rate of rise in profits slowed down for about four months, but it is now right back to soaring. The 2024 numbers don’t even show, yet, but the jump in profits for Q4 of last year alone was 5.4% over the third quarter … well above the quarterly inflation rate.
This spike in profitability in inflationary times is a sign that companies hiked prices much faster than their costs – including labor costs – went up, that they were able to do so without losing customers, and that they were confident that they would not lose customers by hiking prices, and thereby doing their part in refueling the inflationary momentum we’ve been seeing for the past few months. Companies are able to do it because their customers are willing and able to pay those prices.
For banks, however, profits fell in the fourth quarter, and that was the only major industry that did see profits fall. No wonder Powell wants to get on to rate cuts, in spite of rising inflation that is holding his feet to the flames in a time of a “strong economy” and “resilient labor.”
Lots and lots of soaring profits, month after month, indicate inflation is alive and well. We know, of course, it tends to take major job losses and a recession to dent consumers enough to get their spending back down, and that is exactly the main thing Powell, as noted, is not seeing in the employment numbers
Inflation and the energizer bunny
And then we come to Powell’s biggest pain in the neck. The one thing that helped the Fed get inflation down more than anything else was a drop last year in oil prices. I said months ago that oil was not likely to cooperate so nicely with Powell this year, and now it is not. An article in Forbes today says that gasoline prices are rising across the nation and are likely to continue to rise through the summer just like rents are doing. It was in the second half of last year that oil (and particularly gasoline) gave the Fed a break. In the first part of last year, it did as it is doing now, but not running as high.
Forbes notes the things that I said earlier this year were very likely to become contributing factors to a resurgence in energy inflation:
Upwardly mobile gas prices are nothing unusual at this time of year. They almost always rise as refineries make the changeover from winter gas blends to the far more numerous summer blends mandated by EPA haze regulations, and many undergo periodic maintenance to be ready for the summer driving season to come.
This year, the upward pressure on prices is more intense thanks to global events and market factors creating a kind of perfect storm in the near term, and an even more difficult supply and demand outlook for the longer term….
Ongoing attacks by Yemen’s Houthis on shipping traffic moving into and out of the Red Sea continues to deny container ship and oil tanker traffic access to the Suez Canal, forcing the ships supplying the North American and European markets to take the long way around Africa.
Member nations in the OPEC+ oil cartel recently renewed their commitments to restrain their own export volumes as a means of supporting the international Brent price for crude at a floor of $80 per barrel. While it has experienced some major hiccups, members of this cartel have displayed remarkable discipline since it was created at the end of 2016 by joining OPEC with Russia and other non-OPEC exporting countries. There seems no reason to expect that discipline to fall apart as 2024 progresses.
A rise in oil prices will drive up the price of every thing and every service, which will certainly help the flame burn higher around Powell’s feet. With WTI up at $83/bbl today and rising and Brent at $87.5, we’re not that far from breaking the $90 mark that someone was predicting in the news yesterday.
Fed fantasies fold, and stocks will too
For the most part, Fed speakers are backing away from the kind of nonsense they sputtered late last year about rate cuts not being that far off. Now they are saying, as the Fed’s Waller did just today, that the Fed probably shouldn’t rush into those cuts and that inflation data of the last two months is looking particularly sticky. They are starting to note such obvious things as “Why would we cut rates when the economy is strong and job market strong and stocks are soaring to record bubble levels?” (My paraphrase.)
Recent disappointing inflation data affirms the case for the U.S. Federal Reserve to hold off on cutting its short-term interest rate target, Fed Governor Christopher Waller said on Wednesday, but he did not rule out trimming rates later in the year.
“There is no rush to cut the policy rate” right now, Waller said in a speech at an Economic Club of New York gathering. Recent data “tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2%.”
Rate cuts are not off the table, however, Waller said, noting that further progress expected on lowering inflation “will make it appropriate” for the Fed “to begin reducing the target range for the federal funds rate this year.”
Here is the thing, though: talking about not cutting rates right away is far from talking about actually raising them a notch soon. So, if the rest of the Fed is as reluctant to believe, as it appears Powell is, that this year’s inflation will continue to rise, their desire to move to lowering rates sometime later this year, will certainly cause them to hold off on raising rates until inflation is back out of control.
By making the mistake of not raising rates a notch in March (and probably not in the next few months either) because they are leaning on the hope that January’s and February’s rise in inflation will prove to be transitory (a word Powell now particularly avoids actually using as he talks about those pressures going away on their own … like transitory things do), Powell could really be pouring gasoline on the fires around his feet. That would be OK if the only one he was roasting was himself.
Some are now calling Powell’s new transitory wish the “inflation bump thesis.” If March inflation comes in low, showing January and February to be a mere bump in the road, all may be well, so long as March is does not prove to be just a head-fake, itself. The strong inflationary forces above say Powell is not likely to get that break.
One particular bet in the bond market this year, also in today’s news, being long breakevens, says bond investors are not buying Powell’s inflated hopes.
The Fed chief made clear last week that he’s now no longer singularly focused on crushing inflation. He signaled enough progress has been made on that front — the annual core rate is down to 2.8% from 5.6% two years ago — to allow policymakers to accelerate the move toward interest-rate cuts if the unemployment rate were to suddenly spike….
“I guess they are willing to tolerate a little more inflation than what we otherwise would have thought,” said Magnusson, the hedge fund’s chief investment officer.
Maybe quite a little. Powell couldn’t have done much more to talk the stock market up than he did by continuing to breathe the “cuts are coming soon” hope and helium that are lifting market hysteria, which is loosening finances even more to breathe oxygen into the flames of inflation.
I say, the rest of us better hope the transitory of 2024 is not the transitory of 2021 and the first half of 2022 or we get to do all of this all over again (or, at least a big part of it), and that, too, has been my prognosis—inflation rises again and forces Powell to tighten harder as labor refuses to given him an excuse to do otherwise, at a time when banks have already had about all they can take. So, something big breaks, stocks crash, and the economy crashes into recession because of inflation and the difficulty of Powell’s fight against it.
We can thank the Fed for that … and hold Powell’s feet to the fire he created and then threw gasoline on if he doesn’t raise rates a notch to take the lunacy out of the stock market’s melt-up and tighten back down on the loose financial conditions that his loose words in November created. This rise is something that needs to be cooled off right away because inflation creates its own updrafts that become fire tornados.
Either, way, stock investors will buckle at the change in course that inflation is forcing. It is so opposite of everything they have priced in. I think there is little chance Powell actually tightens a notch. At most, he takes rate cuts off the table for 2024, which will likely crash stocks anyway, but it will not likely curb the new and eager rise in inflation … until crashing stocks and a stagflationary economy do the job for him.
After all, “the best cure for high prices … is high prices.” Unless, of course, the Fed does one of its knee-jerk jumps back into easing to save the crashing banks, then you have this:
