Just ahead of the the FOMC’s two day deliberation over a potential interest rate hike, the BLS released August’s inflation data this morning. Headline inflation or the Consumer Price Index for Urban Consumers (CPI-U) fell a seasonally adjusted 0.1% for the month of August, in line with economists’ expectations. This follows July’s lacklustre 0.1% CPI-U growth which was below expectations. For the year ending in August, non-seasonally adjusted overall inflation was 0.2% for the second month in row.
Core Inflation, which excludes food and energy was up a seasonally adjusted 0.1% in the month of August. This follows an increase of 0.1% in July, which was driven by a spike in the cost of shelter. We continue to see a large disparity between core and overall CPI as food and energy prices remain very volitile.
Seasonally Adjusted Monthly Numbers
In August, lower energy prices were not quite offset by higher prices for food, apparel and energy services, sending seasonally adjusted inflation below zero for the month.
Seasonally Adjusted Monthly % Change in CPI-U by Category (2016)
|Fuel Oil (non seasonally adjusted)||-6.5||-2.9||1.7||1.9||6.2||3.7||-1.5
|Utilities (piped gas service)||-0.6||1.0||-0.7||0.6||1.7||-0.4||3.1
|All Items Less Food and Energy||0.3||0.3||0.1||0.2||0.2||0.2||0.1
|Services Less Energy Services||0.3||0.3||0.2||0.3||0.4||0.3||0.2
|Medical Care Services||0.5||0.5||0.1||0.3||0.5||0.2||0.5
The energy index was down 2.0% for the month for August due to a drop in gas prices. On a seasonally adjusted basis, the gasoline index fell 4.1% in August following 3 consecutive months of growth including a 10.4% spike in May. Before seasonal adjustments, gas prices were 5.4% lower in August (see graph below). The price of fuel oil also fell a drastic 8.1% in August adding to declines in June and July. At the same time, energy services including electricity and piped gas were more expensive in August, climbing a seasonally adjusted 0.3% and 1.2% respectively.
The index for food climbed 0.2% in August, driven by significant growth in the price of fruits, vegetables and eggs. The fruits and vegetable index was 1.5% higher for the month. The price of eggs also spiked 7.7% while the indexes for meat, fish and poultry were generally lower.
Without food and energy, which are very volatile, the index for all items or core index increased 0.1% for the second consecutive month. This includes the shelter index which continues to climb, increasing 0.2% in August following larger increases in June (+0.3%) and July (+0.4%). Growth in shelter costs continues to be a major driver of core inflation. Price increases were also seen in apparel, tobacco, alcohol, medical care commodities and non-energy services.
After falling 5.6% in July, the price of airline tickets continued to decline in August, down 3.1% for the month. Other factors keeping seasonally adjusted inflation below zero in August include declines in the prices of used cars and trucks (-0.4%), household furnishings (-0.3%) and recreation (-0.1%).
Year over year, the all items index increased 0.2% in August. The number, which has been rising since April, was also 0.2% in July. Food and shelter costs were significantly higher over both annual periods. Prior to seasonal adjustment, the price of food was up 1.6% for the year ending in August, the same as the year ending in July. Shelter costs were 3.1% higher for the 12-month period. The indexes for transportation, medical care services and non-energy services were all higher, up 2.1%, 2.2% and 2.6% respectively.
Despite higher prices in many parts of the economy, sever declines in energy prices for the year ending in August kept inflation tame. The energy index fell 15% for the year ending in August including declines in all major components. The most drastic fall was in the price of fuel oil, down 34.6% for the year. The gas index was down 23.3% and piped gas services were 11.5% cheaper for the year.
The index for all items less food and energy was in line with July, rising 1.8% over both 12-month periods. August marks the fifth time in 6 months that the 12-month change in core inflation was 1.8 percent. Annual core inflation was driven by higher prices for shelter, health care, new vehicles and recreation. While apparel, used vehicles, household goods and air travel have all posted 12-month price declines.
Outlook for the Fed
A high inflation number would have been welcome news for the Federal Reserve as it would have been a missing piece pointing to a strengthening economy and giving them the opportunity to raise interest rates for the first time since 2006. Most other U.S. economic data is more positive. Unemployment was down in August for the third consecutive month and hovering around what the Fed considers ‘full employment‘ at 5.1%. However, with inflation quite stagnant, a rate hike is unlikely this month
Emerging markets, struggling since the recent downturn in China, would be vulnerable to a U.S. rate hike. Higher rates would strengthen the U.S. dollar. Emerging markets, with U.S. dollar denominated debt would struggle to repay loans. Markets are currently pricing in a U.S. rate hike in December. Today’s inflation data was inline with expectations and will not change the market’s expectations regarding the timing of rate increases.
On Wednesday, the Bureau of Labor Statistics released inflation data for July that was slightly below expectations. For the month, the headline number or Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1% compared to a median estimate of 0.2% for analysts polled by Bloomberg.
For the 12-month period ending in July, inflation was only 0.2%. This number includes consistent declines in monthly CPI numbers for October 2014 through January 2015. Year over year, core inflation, which excludes food and energy, climbed 1.8%. This is exactly in line with expectations and equal to the core annual inflation number reported four of the past five months.
July’s CPI numbers follow increases of 0.4% and 0.3% in May and June respectively and point to a loss of momentum. Sluggish inflation means the Federal Reserve may be hesitant to raise rates in September. The Fed’s key interest rate has hovered around zero since December 2008 but a series of rate hikes has been widely anticipated to start as early as next month. Weak inflation coinciding with global economic troubles could indicate that the US economy is not ready for higher interest rates.
Crude Oil Prices Tumble in July
The Energy index fell 14.8% for the year ending in July, despite an increase of 0.1% in July. Crude Oil went from around $58/barrel to below $46/barrel in the month of July alone; such low prices have not been seen since 2009. However, gasoline prices edged higher by 0.9% in July following increases of 3.4% in June and 10.4% in May. Year over year, the gasoline index has still slid 22.3% due to the sharp declines in the second half of 2014. Aside from gasoline, all other major components of the energy index fell in July. Year over year, all components of the energy index are significantly lower with fuel oil posting the largest 12-month decline, down 29.7%.
Declining oil prices have sparked competition among airlines and fares fell a staggering 5.6% in the month of July. Low fuel costs have slowly filtered through to consumers resulting in the largest monthly decline in airline tickets in nearly 10 years. Economists do not expect prices to remain low for long.
Food and Housing Costs on the Rise While Wages Remain Stagnant
The food index climbed 1.6% for the year ending in July, including a 0.2% rise in July alone. All six major grocery store indexes were higher for the month, led by dairy products, up 0.8%. The price of fruits and vegetables rose 0.3% in July. The year ending July saw drastic increases in the price of eggs (24.9%) and beef (10.0%). Compared to a year earlier, food at home is 0.9% more expensive and food away from home is costs 2.7% more
Shelter costs are up significantly (3.1%) year over year. In July, shelter costs posted their largest monthly gain (0.4%) since February 2007. This is largely due to higher rental costs as available housing continues to dwindle. Vacancy rates for rental units are near their 22-year low. The graph below shows that this trend has been consistent since 2010. The problem, according to Diane Swonk, chief economist at Mesirow Financial in Chicago is that “rents are surging and in the face of stagnant wages [which] leaves less for consumers to spend elsewhere in the economy.”
The July jobs report showed a small decline in unemployment, down a marginal 0.02% to 5.26%, which is a 7-year low. Employment growth has been healthy and consistent but wage growth has lagged previous economic recoveries. David Kelly at JP Morgan blames low headline inflation numbers, among other factors, for lacklustre wage growth.
Outlook for the Federal Reserve
Growing concern over the health of the global economy could delay or slow the pace of interest rate hikes at the Federal Reserve. China’s surprise devaluation of the yuan should be a major concern for the US economy. Other emerging markets could potentially follow suit if they wish to remain competitive with China. This could spur global deflation. Import prices will certainly fall in the US. Combined this with drastically dwindling commodity prices and a strong dollar and there is little to support price growth. Although the Fed has stated that they may still raise rates despite low inflation, it is a key factor they will need to consider. Raising rates in a deflationary environment is unlikely.
Commodity prices have been plunging in recent weeks, with the Bloomberg commodities index falling to an 11-year low, a drop of nearly 42 per cent since its peak in 2008. Plunging prices for natural resources are stoking real concerns that the deflationary conditions which plagued the US economy during the first quarter of 2015 could return with a vengeance in the months ahead. Commodity markets have been under pressure for most of the year on expectations of an imminent rate hike by the Federal Reserve, but the rout has been accelerating viciously in recent weeks due to ongoing concerns with a broad based economic slowdown in China. While the Chinese stock market has been grabbing headlines for the past few months, the real danger lies with problems bubbling under the surface of the country’s “real” economy. Recent Purchasing Manager Index data from China has been abysmal, with the latest figures showing PMI at a 15 month low. Growing signs of stress amongst Chinese purchasing managers does not bode well for the world at large. Slowing demand worldwide combined with an oversupply of inventory due to excessive production in China is likely to trigger another wave of deflation in the coming months – which should, all else being equal, curtail any potential rate hike by the Fed.
Central Banks are EASING Globally
Compounding the situation at the Fed is a scramble amongst central banks across the world to increase their monetary stimulus packages to help contain the economic carnage which has been unleashed in their respective nations due to interest rate differential expectations in some cases, and plunging commodity based revenues on the other. Canada was the first country to concede “all is not well”, with the central bank cutting interest rates and lowering its GDP forecast for the rest of the year due to falling oil sector investment. Both Australia and New Zealand have followed suit, with both countries looking increasingly vulnerable to any potential slowdown in China. The currencies of both countries have fallen sharply in value in recent months – with no sign of relief in the near future.
In the case of China, it is estimated that the country experienced $224 billion of capital outflows in the second quarter, an eye watering number which has forced the PBOC to tap into its foreign reserves in order to defend the Yuan. If China is having to resort to such measures to defend its currency, what chance do more vulnerable emerging markets have? Nations like Brazil, South Africa, Indonesia, are all seeing severe currency crises which in some cases could spark into full blown regional banking crises should the current financial conditions persist.
So where does this leave the Fed? In no uncertain terms, an increase in rates by the Fed any time soon will push the vast majority of the world over the proverbial edge, and it wouldn’t take long for the ramifications of such economic pain to begin reverberating within the US economy itself.
The Fed’s hands are tied… again
The unfolding commodity carnage will start to impact wall street GDP forecasts and earnings estimates in the days and weeks ahead as analysts begin to digest the implications of slowing demand worldwide. Downward revision to GDP forecasts will be the death knell for rising rates, and will eclipse any positive data which may be appearing on the employment front. Once again the Fed will find itself trapped between seemingly “improving” signs domestically, and full scale carnage internationally. The long run implications of this dilemma are worrying. Should deflationary pressures increase dramatically in the coming months, there will be an expectation on the Fed to embark upon the same easing measures which have led to the current situation in the first place. China undergoing a period of market turmoil as a direct result of the zero interest rate policies being implemented by central banks all over the world. The inflation which failed to show up in developed economies, was unleashed with a vengeance in Chinese financial assets. The market may very well expect and demand another round of QE, and they may very well even get it, but the question has to be asked, will it matter any more? And if it doesn’t matter, what comes next? The answer to that looks increasingly like a breakdown in faith in central banks, as they fight wearily on against increasingly frequent financial storms.
U.S. consumer prices increased for the fifth consecutive month in June, led higher by a rebounding price of gasoline, although there was nothing in the latest release which should pose any immediate alarm for markets or consumers at large. The latest report from the BLS reported an overall increase in headline inflation of 0.3% month on month – an increase that was inline with nearly all economists polled prior to the announcement. Looking at the headline number on an annualized basis, inflation rose 0.1 percent In the 12 months through June, following an unchanged reading for the month of May.
Gasoline prices rose 3.4% month on month, following a 10.4 percent surge in May. Given the recent volatility in crude oil prices and inventory data in July, there could be scope for the influence of rising gas prices to subside in coming months. Oil is currently trading within the $50-60 / bbl range, well below the levels seen in May and June.
Core CPI, which excludes food and energy related costs, increased 0.2 percent month on month following a rise of 0.1% previously. On an annualized basis, core CPI has now risen 1.8 percent.The June reading continues to highlight just how tame the inflationary environment is within the US economy at present. The strong dollar is helping to keep a lid on inflation by reducing the price of imports and wholesale costs. The strong US dollar has been been spurred partly by a flight to safety due to concerns in Europe and China, and partly by the market’s anticipation of a Fed rate hike later this year. We should expect to start hearing comments regarding the damaging effects of the stronger dollar by Fed officials in the weeks and months ahead should this trend continue.
The food index posts largest increase since September 2014
The price of food increased 0.3% in June, largely to an ongoing shortage in wholesale eggs which has caused a sharp jump in retail egg prices across the nation. Egg prices jumped 18.3% in June, the largest monthly gain since August 1973. Elsewhere, the index for meats, poultry, fish, and eggs rose 1.4 percent in June, with the beef index rising 0.9 percent. Food prices are likely to remain elevated in the coming months as the aftermath of the bird flu epidemic works its way through the supply chain. Wholesale food costs have been consistently increasing in PPI surveys, and these costs are likely to make their way down to the consumer in the weeks and months ahead.
Medical Price Inflation starting to cool off
Medical related inflation cooled in June which will be a welcome deviation from the overall trend in 2015. The price for Medical Care Services fell -0.2% in June and the prices for Medical Care Commodities remained unchanged month on month. Health care costs have been one of the largest contributors to inflation over the past 12 months, with both indices rising 2.3 percent and 3.3 percent respectively.
Rent Prices continue to Climb Higher
The shelter index climbed 0.3% in June, and 3% on an annualized basis as the supply of housing continues to shrink in key regions. Rent increases are also amongst the largest contributors to overall inflation in the United States within the past 12 months.
Outlook for Rates
This month’s CPI data contains no surprises, and the relatively tame reading in the core number on the back of the strong US dollar will likely stick in the minds of Fed officials in the weeks ahead. Globally, sentiment continues to wane dramatically given the continued turmoil in Greece, and increasingly China. While Greece appears to be on the verge of some sort of political settlement, the headline risk remains. In China’s case, there is a very real danger of investor sentiment turning, which could spell disaster for emerging markets overall. Latin American and South East Asian markets look at particular risk, especially on the currency front. The fate of these regions would be sealed in no uncertain terms should the Fed raise rates, and it is for this reason that it appears increasingly unlikely that the Fed will raise by year end, despite all of their rhetoric and expressed intention to do so.
Rising tensions within global financial markets were the dominant concerns among Fed officials according to minutes just released from their June policy meeting, leading to yet another delay in the Fed’s widely anticipated normalization of interest rate policy. Uncertainty surrounding the future of Greece and ongoing market weakness in China triggered a cautious tone among most members, although signs of continued strength in the domestic economy, especially the labor and housing markets provided enough signs encouragement for other members to favor a rate hike in the near future.
The tug of war between these two forces will be the dominant theme for Fed watchers going forward, and signs of either beginning to dominate in the weeks ahead should offer some more concrete insight into the timing of the Fed’s next move.
In the Fed’s own words:
“Many participants emphasized that, in order to determine that the criteria for beginning policy normalization had been met, they would need additional information indicating that economic growth was strengthening, that labor market conditions were continuing to improve, and that inflation was moving back toward the Committee’s objective.”
The Fed is essentially adopting a “wait and see” approach before pulling the trigger on a rate hike which might seem premature in hindsight.
The Good – Labor Market Continues to Pick Up
On a positive note, job creation and improved employment prospects according to official figures has buoyed the Fed’s expectations for wage growth to pick up for the rest of the year. Recent consumer confidence surveys echo the Fed’s optimism, with average consumers hopeful of real wage increases in the coming months. Increased wage growth would help boost the domestic economy going forward, and the Fed will likely keep monitoring the retail sales data and employment figures closely in the weeks and months ahead for signs of a solid platform of growth emerging.
The Bad and The Ugly – Greece Weighs on Fed Outlook
Dissecting the June minutes in more detail reveals the Fed’s growing concern about the disruptive influence of overseas market turmoil arriving on domestic shores. Greece clearly weighed on policy makers minds, with particular focus on the contagion “Grexit” would cause for European financial institutions, and the domino effect this could have on US banks.
The Fed didn’t mince any words in this regard.
“[M]any participants expressed concern that a failure of Greece and its official creditors to resolve their differences could result in disruptions in financial markets in the euro area, with possible spillover effects on the United States.”
An important point to note is that the June FOMC policy meeting took place well before the most recent turmoil in Greece really flared up. It’s almost certain that the Fed would be adopting even softer language surrounding Greece given recent events. The Chinese stock market has also imploded in recent weeks, and is likely to overshadow even Greece in the near future as the biggest threat to worldwide economic stability. In recent weeks China has employed a variety of increasingly desperate measures to help slow the stock market decline, but neighboring countries in the Asia Pacific region will be looking on anxiously for signs of contagion in the near future.
Inflation continues to remain below target
On the inflation front, the minutes identified stabilizing oil prices as a potential boost to inflationary pressures within the economy in the coming months. The Fed expects increased energy costs combined with a tightening labor market to help push inflation back towards its target of 2% by the end of year – current levels are well below target.
Summing up the inflation environment and economic picture in the Fed’s own words:
“The information reviewed for the June 16-17 meeting suggested that real gross domestic product (GDP) was increasing moderately in the second quarter after edging down in the first quarter. Labor market conditions improved somewhat further in recent months. Consumer price inflation continued to run below the FOMC’s longer-run objective of 2 percent and was restrained significantly by earlier declines in energy prices and decreases in prices of non-energy imports. Survey measures of longer‑run inflation expectations remained stable, while market-based measures of inflation compensation were still low.”
In summary, it is clear there is growing sense of frustration within the Fed with regards to its inability to start normalizing rates which have been set near zero percent since the onset of the 2008 crisis. With ongoing stress in world financial markets, the Fed knows a premature hike in rates would be enough to send many nations over the edge into a full blown recession. Upcoming domestic data will be key in the coming weeks, should there be a deterioration in the domestic economic picture, then all bets for any form of rate hike this year would certainly be off.
One of the more interesting sets of data to catch our attention in recent months is the National Association of Credit Managers CMI Index – a broad measure of the underlying credit conditions affecting both the manufacturing and service sectors in the US economy. The CMI has proved to be a valuable leading indicator since its inception in 2002, successfully predicting both the start and the end of the credit crisis in 2007 and 2009 respectively.
Given the important role credit plays in the overall economy, following a gauge of credit conditions on a month to month basis provides an excellent insight into just how healthy the flow of credit is throughout the business sector. From this vantage point, the trend emerging from recent data is worrying on all fronts and could have serious ramifications for the economy in remaining quarters of 2015.
Full Blown Recessionary Signal in March (or is it… )
In March, the CMI data recorded the biggest deterioration of business credit conditions in over 7 years. The fall in the unfavorable factors part of the index, tumbled from 50.5 to 48.5 – the lowest level since the 2008 recession formally ended. The data turned the heads of many analysts due to the severity of the drop. In the NACM’s own words:
“There is quite obviously some serious financial stress manifesting in the data and this does not bode well for the growth of the economy going forward. These readings are as low as they have been since the recession started and to see everything start to get back on track would take a substantial reversal at this stage. The data from the CMI is not the only place where this distress is showing up, but thus far, it may be the most profound”
Thankfully, if not somewhat surprisingly, the NACM made significant revisions to the March data in its April release – with the sharp falls in February and March replaced with less apocalyptic data points. The massive declines in February and March were revised from 52.1 and 46.1 respectively to 60.5 and 60.6, quite an enormous revision, and one which the NACM were rather vague in explaining. Again, in their own words:
“In February and March the CMI seemed to show a drastic drop in the amount of credit extended by companies to those that wanted to buy their machines or commodities and inventory. There was also a big drop in the number of credit applications submitted. Many of the other categories were also in decline, but these were the most dramatic. Upon reviewing the data and assessing some of the additional numbers it seems that there was not quite the drama originally noted.”
So.. credit crunch avoided, but the data has stoked our curiosity about what exactly did occur in February and March. If credit conditions deteriorated so badly during this period, the trend should surely be mirrored in the consumer credit data – we cracked open the Fed’s latest Consumer Credit report to take a look.
Consumer Revolving Credit Slowdown
While the Fed’s consumer credit lags the NACM (the Fed only has data up until March, the NACM CMI is current through the month of April) the data nevertheless appears to confirm the initial view from the CMI – a significant deterioration in credit availability did occur in the first quarter of 2015. From the Fed’s data, revolving credit fell -3.3% in both January and February of this year before rebounding +5.9% in March, signalling a severe slowdown in credit creation in the early part of the first quarter from non government sources. This was the worst month for revolving credit (predominantly credit cards) since December 2010 and paints a worrying picture regarding the health of the US consumer going forward.
Compounding the sluggish consumer, there also seems to be credit aversion occurring throughout the big banks, with the Fed’s data showing outstanding consumer credit held at depository institutions down -2.5% from the fourth Q4 2014 to March 2015. It would appear from this data that the big banks have pulled their horns in with respect to extending credit to both businesses and consumers in the first three months of 2015 as uncertainty reigns supreme with regards to the timing of the Fed’s next rate hike.
Both data sets have certainly caught our interest and we will be monitoring the Fed’s latest credit report scheduled for release on June 7 for signs of how the current trend is progressing. In the meantime, the data clearly shows the economy is in far less robust health than those calling for a rate hike would care to imagine. The recent fall in global PMIs and factory orders in the US are further signs of a slowdown occurring – we have been calling for an extended period of delayed rate hikes for a while, but this current data seals it.