by Jim Rickards, Daily Reckoning:
The January inflation numbers came out this morning, and they weren’t good for Wall Street.
The consumer price index (CPI) rose 3.1% in January. That’s a decrease from December’s 3.4%, but it exceeded consensus estimates of 2.9%.
Core inflation, which excludes food and energy, rose 3.9% on an annualized basis, which is unchanged from December. But the consensus estimate was 3.7%. Core inflation also rose at its highest rate since April 2023.
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Here I want to make an important point about core inflation. From the point of view of everyday Americans, core inflation is nonsense.
Gas in the car, home heating and food on the table are large parts of the total spending of most Americans. Taking them out of the inflation calculation is something only the eggheads would do.
When Americans provide for their families, they don’t pay “core,” they pay regular CPI. That’s all you need to know when it comes to public policy, citizens’ well-being and (for politicians) how people will vote. For the record, 3.9% inflation cuts the value of the dollar in half in 18 years.
Sorry, Wall Street — No “Pivot”
The stock market threw a temper tantrum once the inflation news broke this morning, with all three major averages tanking. By the end of the day, the Dow lost 661 points, while the S&P lost 90 and the Nasdaq lost 350.
But the good news for Wall Street is that today’s inflation data won’t cause the Fed to raise rates. In the Fed’s December meeting, Jay Powell essentially confirmed that the Fed had reached what they call the “terminal rate.”
The terminal rate is defined as a rate that’s high enough to bring inflation down on its own without further rate hikes. By the way, a terminal rate is an invention by the Fed. There is no discussion of terminal rates in economic literature, and it’s not something the Fed has ever used as a policy tool. The Fed just made it up.
But the Fed believes in it. So Wall Street can at least be thankful that the Fed is done raising rates. But today’s report also signaled to the Fed that inflation remains an issue, and that its ideal 2% target remains elusive.
Inflation and the Economy
What does inflation indicate for the real economy outside of Wall Street? It’s hard to say. Inflation is meaningful on its own, but it has no correlation to the business cycle.
In the early 1960s, we had low inflation and strong growth. In the late 1970s, we had high inflation and weak growth. In the late 1990s, we had moderate inflation and strong growth. In the 2010s, we had low inflation and low growth.
Does anyone see a correlation there? There isn’t one. Growth and inflation are empirically uncorrelated. We can agree that inflation is bad, but inflation tells us nothing about the prospects for growth.
At any rate, you can basically rule out a March rate cut. The Wall Street crowd who’s been waiting for the Fed to “pivot” will have to keep waiting. After today’s report, the market’s giving just 8.5% odds that the Fed will cut rates next month.
Having said all that, today’s report doesn’t come as a surprise to me. As I said almost a month ago, “Is inflation over? Actually, no. And it may be getting worse.”
(I’ll be going live tonight at 7:00 p.m. ET as part of the Zero Hedge debate series on the future of the U.S. dollar. If you want to check it out, go here to learn how.)
Inflation Is Often out of the Fed’s Control
Inflation can increase on its own for reasons that have nothing to do with Fed policy. Supply chain disruptions, economic sanctions, pandemics and demographics are all examples of factors that can drive inflation higher or lower regardless of the Fed.
The first flaw in the model-based forecasts is the failure of analysts to distinguish between inflation that emerges from the supply side and that which emerges from the demand side. The difference is crucial from a forecasting perspective.
The inflation of 2021–2023 was real but it was caused by supply chain bottlenecks and shortages of critical goods and industrial inputs. The supply chain disruptions were exacerbated by unprecedented economic and financial sanctions because of the war in Ukraine.
This kind of supply-side inflation tends to be self-negating. The high prices cause reduced demand, which in turn tends to lower prices. We’re seeing this every day starting at the gas pump where the record high prices of the summer of 2022 have come down significantly (although still higher than 2021).
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