Join Ylan, John, and Brendan on the Macrocast this week as they discuss the unexpected inflation data and its ripple effects. They discuss January's inflation rates and how they will impact the Federal Reserve's interest rate policy leading up to election season. They also break down retail sales and discuss if the soft landing is likely amidst the tension between layoffs and resilience in various job sectors.
The group also discusses the dichotomy between the U.S.'s growing economy and technical recessions in major economies like Japan and the U.K. Next week, we will sadly bid farewell to our current podcast format, so make sure to join us for this episode and stay tuned for next week!
Join Ylan, John, and Brendan on the Macrocast this week as they discuss the unexpected inflation data and its ripple effects. They discuss January's inflation rates and how they will impact the Federal Reserve's interest rate policy leading up to election season. They also break down retail sales and discuss if the soft landing is likely amidst the tension between layoffs and resilience in various job sectors.
The group also discusses the dichotomy between the U.S.'s growing economy and technical recessions in major economies like Japan and the U.K. Next week, we will sadly bid farewell to our current podcast format, so make sure to join us for this episode and stay tuned for next week!
Hello everyone and welcome to this episode of the Macrocast. I'm your host, elon Mui, a managing director at Penta. My co-hosts are John Fagan and Brendan Walsh of Market's Policy Partners. Hey guys, good morning. Good morning, well, it's a good morning, but some of the economic data that came out over the past week may not be so good. Inflation coming in hotter than expected, retail sales weaker than expected the market's going crazy about all of that, all of those numbers. Let's just go ahead and dig right into some of this. Maybe we start by looking at inflation, which actually accelerated in January. The consumer price index rose 0.3% from the previous month, compared to a 0.2% increase the month before. Year over year it was up 3.1% when the market had been hoping for a sub 3% number. It looks like this is why the Fed is saying that it needs more confidence before it's willing to start cutting rates.
Speaker 2:Definitely the last month's numbers were what John and I were worried about going forward, where we had those six months of goods deflation actually dropping prices. Now those are settling out, but service inflation is still kind of running at a normal pace. The other kind of quirk to it is the housing numbers still haven't started to come down. That's in the pipe line. Even with that, if you're the Fed, you kind of have to maybe strip that out and look at the components of everything else. The shipping disruptions are definitely starting to play a role in it. I think that played a role in the producer price index that came out this morning, which was much higher than people expected. That kind of leads the CPI by three months. This is stuff now that's in the pipeline for the spring.
Speaker 1:You mentioned the shelter cost. The Bureau of Labor Statistics said that the rise in shelter cost contributed to about two thirds of the jump that we saw in the CPI. Is mortgage rates part of the issue here? Is that feeding into it, or why are we seeing shelter costs remain so stubbornly sticky?
Speaker 2:It's just the way that the BLS computes it. They do it on a six and 12 month rolling average. Their shelter components are very, very backward looking. In normal times it works, because usually house prices don't massively go up and down. But the pandemic kind of put a little goofiness into that. They're not going to reinvent it for the short term and take away all that historical data. Also, the Fed is aware of this. They're able to put in real time data into the monthly ones if they want.
Speaker 2:That will start to seep through because we already know what happened the last six months. Especially rent prices have come off a lot in the last six months. That will start to feed through. Like you said, it was two thirds of the increase in really both the headline and the core. Their concern now is one that goods prices might start creeping back up Even bigger. The services inflation outside of housing it's not going crazy but it's ticking back up. Maybe two months ago we thought that we're going back down to 2% pretty quickly. That outlook isn't quite as certain today as it was maybe A couple of months ago.
Speaker 3:Yeah, I think that's the key to certainty. After those CPI numbers came out, the ink wasn't dry on the report. When analysts and economists that have been touting the soft landing story and continual improvement inflation narratives die hard on Wall Street, they were coming roaring out of the blocks to explain why January CPI was nothing to see. Here it was hey, there are seasonal adjustments and there are seasonal distortions early in the year and an echo from the weirdness of the start of the pandemic is still coming through in the first quarter CPI numbers. And, by the way, the Fed doesn't even focus on CPI. They focus on core PC. Core PC is likely to be, it's essentially like. And then look at the three and six month moving averages and they're still coming in Right. You can see here the Fed is still on track to cut rates.
Speaker 1:I'm taking a breath, John. I'm exhausted listening to you.
Speaker 3:Like the sort of shrillness with which the pushback came is, I think, a testament to just how wedded people are to this narrative and just how high the conviction has been in the markets. And we've seen that faith shaking again today. But a similar exercise has sort of played with the retail sales number and it was a real stinker. And retail sales in January and cue the discussion about how it was all about the weather. This all may be true, right, and reading too much into one data point is not going to get you where you want to be as an investor. But I think that that's what we're going to do. That goes back to the point of Brendan's that Brendan closed with there, which is conviction in this soft landing scenario had just been too high and we're just in a lower conviction equilibrium. These are the kind of data points that shake markets out of their complacency. The optimists may end up being right, but it's a lot less clear in the picture than they had previously thought.
Speaker 2:And that was kind of the point that we've been making. It wasn't that we had this huge view that inflation was going to massively go up the bigger one that the first half of the year was going to be bumpy and, most importantly, that the Fed really didn't want to cut as much as the market had been pricing in. So we kind of thought that June might make sense for the first and that's looking much and more like a reality and the market now has priced that. The March cut is completely priced out of the market. We'll see kind of how the data goes, whether June does it. But you have that dynamic because the outside of inflation, the rest of the data this week was pretty weak. We are seeing slowing. We're also seeing more and more layoff announcements and things like that. So the labor market still is holding in there but it's certainly not the super duper strong, especially in that white collar management role. That's where you're seeing the layoffs. The service sector and hospitality and healthcare, they're still doing quite strong.
Speaker 1:Yeah, I think it's kind of funny that the no-landing scenario was kind of heralded as the optimal case, actually after we saw some of the big jobs numbers at the end of last year. And now it seems like folks are worried that no-landing is actually not a good thing because it means that inflation is not necessarily going to come back down to where you want it to be, and that's going to mean the Fed has to stay higher for even longer than it had anticipated, and so some of our perceptions of what the optimal scenario seems to be are shifting as well. Yeah, but to your point, any residual hope of a March rate cut just seemed to get completely stomped on after the CPI numbers came out and a lot of this issue has been geopolitical, which you can't put that into the model.
Speaker 2:but things seem to be getting worse rather than better on that front.
Speaker 1:Absolutely, and I thought it was also kind of interesting that we saw the Biden administration come out and try to characterize some of the inflation that we've been seeing. They talked a lot about this idea of greedflation at the beginning of the cycle coming out of the pandemic, or companies hiking prices just because they can, more than what they're seeing in terms of actual supply chain costs that are coming through. They're adding that extra padding on and passing it on to consumers. And now, during the Super Bowl even which I thought was kind of interesting they're talking about this idea of shrinkflation, meaning that prices may be staying the same but you're getting less for your dollar. So I don't know. I felt like my chips were pretty crunchy and my bag of chips was pretty full.
Speaker 3:Yeah, I don't know, lower portion sizes may not be the worst thing in the world in America as America's weights line collectively, but anyway, not to be too glib about it. But yeah, I think the whole not to editorialize too much but the whole greedflation thing, obviously it's a political spin. I think the pushback on it is also political. If you have a situation in which companies find that they have pricing power, they're going to take advantage of it. We've just seen that it's what they do.
Speaker 1:And consumers have been willing to pay it.
Speaker 3:Yeah, and they're going to keep raising prices until it begins to impact demand. And we talked a little bit about this last week. The Kraft Heinz came out this week. It was pretty similar to what we saw from PepsiCo and McDonald's, which is they all missed on sales projections but beat on profit, and that was kind of indicative of the prevailing dynamic of basically consumers feeling a little pinched by these persistent price hikes, but those price hikes looking pretty nice on the profit margin side for these companies. So at some point there's a point where the calculus starts working in the other direction and you begin to get the demand destruction to a degree and the pricing power for these items is not infinite and you start running into headwinds and they're trying to. Obviously these corporations are trying to find where that event horizon is and get as close as they can to it. Maybe, who knows, maybe they're close to it now, given the latest earnings.
Speaker 2:Yeah, and I think, if you're the Fed, that the first quarter earnings and outlooks probably are more important to pay attention to than probably January data, which, as we said, had some weather distortions, but also data is not forward-looking, it's actually very backward-looking, or halfway through February already.
Speaker 1:Yeah, and in terms of the shrink-flation narrative, talk about backward-looking. I feel like that felt like a real thing back in 2022, as companies were trying to figure out how do we grapple with the very real supply chain costs and increases. Do we just raise prices, do we shrink the packages, etc. But it feels like the wrong message for this moment, when that's largely passed by and we're now in a place where consumers are, to your point, john, starting to push back a little bit and close their wallets.
Speaker 3:Yeah, and we wrote a little piece on this there's an ad from Chili's. I didn't know that Chili's hadn't done an advertisement campaign in three years, but they have one out now and it's basically busting on McDonald's for $18 for a Big Mac meal and they say you can come to Chili's and get actually a nice burger and fries for $18. And so that's essentially the message, and this is kind of where these things organically begin to. You get to start the beginning to compete on price again and the capability of doing that in an environment where input prices have stabilized. And then you get opportunistic companies, like Chili's, I guess, who are trying to recapture market share from those companies. So this is how the markets are supposed to work, it's how the economy is supposed to work, they're kind of fundamental dynamics and so hopefully there's an organic pushback here as the markets try to correct from this inflation scenario.
Speaker 1:The last Chili's commercial that I remember is the one with Justin Timberlake, and I'm not even going to try to sing it because it's going to be hugely embarrassing on this podcast. But Chili's baby back ribs I don't know if those are $18 or not.
Speaker 3:Thanks a lot. Now that's stuck in my head for the rest of the week.
Speaker 1:To just stay in line with the Millennial Super Bowl halftime show. I have to think about the Chili's commercial. But okay, so this is a good segue, I will say, into dissecting some of the retail sales numbers a little bit more, because we did see in January that sales at restaurants and bars were still up 0.7% even though folks were cutting back in other areas. So people still want to go out and enjoy a nice beverage with their friends, even during dry January apparently.
Speaker 2:Yeah, and when it was snowing, there's nothing else to do. There might be more accurate than it wasn't weather affected if people were out eating and not drinking, apparently.
Speaker 1:So in terms of what we saw folks cut back on I think building materials, lawn and garden stores, as you would expect, that had a pretty big drop, I think 4%, from the previous month. But were there any other places of weakness that you saw that might be concerning?
Speaker 2:I think we're still going through that transition of where people spent their money when they were locked in their house to now is spending your money where you're out and about and travel. So I think that narrative is still going on. But we're definitely pulling back on a lot of the goods inflation and spending it much more on services, which is not really good or bad, it just is what it is. But when you add up all the numbers, we are spending less, especially on big ticket items. I think people kind of already bought their big ticket and done renovations to their house and then going out to dinner is a lot less expensive than putting a new garden in your backyard.
Speaker 3:Yeah, and Taylor Swift. Taylor Swift Eris Tour bump is over in the US. I guess she's now overseas, so she's been in Japan. I guess. So they just went into a technical recession, but they're obviously going to come roaring out of it here.
Speaker 1:That would be the most amazing headline. John Taylor Swift single-handedly saved Japan from recession. What can she not do really?
Speaker 3:Yeah, but JLo just announced a new tour. So hey, there's your engine of growth for 2024, I guess.
Speaker 2:So anyway, kidding aside, there's Some of Beyonce's touring, though Some of the big names are back out.
Speaker 3:Yeah, it is just. There's sort of this drumbeat of bad news about the consumer debt balances and that sort of stuff and the dry powder and the residual savings from the COVID era splurge being drained, finally and so forth. No big fiscal stimulus on the horizon, although this tax cut is still a possibility here. It's not necessarily easy to see where the consumer is going to get the next uplift and that I think in the US, hope springs eternal. We do have the shop till you drop mentality. But looking overseas, as we mentioned, that sort of technical recession in Japan, technical recession in the UK and a narrowly missed recession in the EU.
Speaker 3:China we all know how the economic outcomes there at Beijing has been pushing harder and harder on the gas pedal, just to stand still, it seems, and their economic data is maybe better than it was over the three, six months ago, but still looks really tepid and adds a gigantic drag from property. So looking, scanning around the world, there just doesn't seem to be a big engine of growth out there. There doesn't seem to be a lot of oomph, a lot of animal spirits running through the global economy. It's understandable in a lot of cases why you would see, with conflict right on the door of Europe and saber rattling in the Taiwan Straits and stuff like that. It's just a dangerous and scary world and a lot of the rest of the world is maybe feeling it more than the US. That's not unusual. But it really is hard to see if we're going to get a big uplift in the no landing scenario and we take off again. What's fueling that take off? It's hard to say.
Speaker 1:Do you think that there's any chance that the Bank of England could move ahead of the US in terms of cutting rates just thinking about the weakness in the economy there? Or do you think that their inflation situation is so much more entrenched than ours is that the Bank of England is really just stuck in a difficult place?
Speaker 3:Yeah, we think that the Bank of England is in one of the toughest of the major central banks, one of the toughest situations given its more distinctly stagflationary problem. But the Bank of England, we think will probably follow the Fed's lead a little bit. But if there is a central bank that, let's say, global growth does stabilize and start to pick up among the central banks, like the risk of having to go back to hikes I think is highest for the Bank of England. I don't think it's very high here because we think that growth will stay low and inflation will be sticky but not reaccelerate, and so we don't think the Bank of England will be forced to go back into rate hikes. But of all the major central banks, we think the BOE is probably the most at risk of that and will probably be on the later side of beginning to cut.
Speaker 1:Interesting, so it's more likely that they end up hiking than they end up cutting, despite the weakness in the economy.
Speaker 3:No, I think they'll probably end up cutting, but I think that if the Fed is at like a 2% chance that they actually have to go back into rate hikes, I think the Bank of England is more like a 10% chance. They've just got. The dynamics of their economy now are look more stagflationary and it's not a comfortable place to be.
Speaker 1:Got it. I want to pick up on something else that you mentioned, john, which is the possibility of maybe a tiny boost of fiscal stimulus from the tax bill, that is, I believe it's passed the House but has not yet stalled in the Senate. Quite frankly, we're also facing the potential for another government shutdown, once again March 1st and March 8th, and the latest reporting that I saw out of Punchbowl was that there is still an appetite among some hardline Republicans to push for not just the shutdown, which would happen if the government is not funded by early March, but also if they haven't passed sort of full year spending bills by April 30th. There would be a 1% across the board sequester, 1% across the board spending reductions for both the defense and non-defense spending, and so that would be actually contractionary, not just so the lights are off and everyone could pay eventually in a couple of days, but real fiscal austerity being imposed. The risk of that seems to be non-zero maybe not likely, but certainly non-zero and that could be another potentially destabilizing moment for the markets.
Speaker 3:Yeah, absolutely, and we've seen the dysfunction. Obviously it's dispiriting and worrisome, obviously on Capitol Hill. But whenever you see these worst case scenarios even as poisonous and toxic climate it is up there, it seems as though the both parties look over the cliff at something like an automatic 1% sequester and back off. Maybe that logic of avoiding worst case scenarios begins to erode as we get closer to a very contentious election, obviously, but the operative assumption is that they'll come up with an 11th hour fix. That's why these things and government shutdowns are aside. That's why we've talked about the potential for a debt limit accident. Essentially, it's always going to be a surprise. If it ever happens, it's going to be a gigantic shock, because we've just seen this movie before and the 11th hour compromise is just so hardwired into everybody's expectations for these things that when a worst case scenario if it does occur, then it would be a meaningful shock.
Speaker 1:Absolutely, and the Fed is operating in a political environment, even though it is not itself, obviously, a political institution. And so, brendan, when you mentioned the possibility of a June rate cut, it seems like that's the latest they can wait, right. If they want to get it done in 2024, you would either need to do it during the summer, right, or you wait till after the election, because once you get too close to November, anything is going to look like it's politically motivated.
Speaker 2:I totally agree and I think that's why they did the pivot at the end of the year, which was ahead of what the market was expecting. But I think they did it for political reasons where they didn't want to seem to be favoring one candidate to another. The market then got a way ahead of itself in how many cuts that they were going to do. But I still think they're on that path to cut it at the beginning of the summer and then hopefully kind of put it on cruise control. We'll do 25 at every meeting and when they cut I think they're going to give a very clear path of it's not meeting to meeting Now. It's already set until after the election.
Speaker 1:Do you think there's a chance that they might do one see how it goes and then sort of wait until 2025 to act again? Because I just wonder, if they sort of set it and forget it, then you're locked into maybe a higher level of rate cuts than maybe you want to be at for this year.
Speaker 2:Yeah, that's the. I mean a lot can change in the next three months before they have to do it four months. But Obviously if they give the guidance they don't have to do it if things massively change. But I think they would prefer to give the market pretty clear guidance on what's coming so they don't seem at all interfering in the election.
Speaker 3:Sure, we've talked a little bit about this before the extent to which the Fed is going to be in the spotlight or dragged into the spotlight of politics. Obviously, former President Trump is not shy about his opinions on the Fed. But Biden is more of a traditional politician and is unlikely to say a whole lot about Fed policy. But Trump is definitely not cut from that cloth. So if they want to stay out of politics, they're going to have a hard time doing that, with one of the candidates potentially talking about them. He's already rift on what he might decide regarding Chair Powell's tenure and so forth. So and his views on how interest rates are too high and that sort of thing. We'll see. There are going to be a lot of other issues on the table in the election. Maybe the Fed will get off easy.
Speaker 2:But it is a weird dynamic because a cut theoretically could help the economy, which would help Biden, but it's also very specifically what Trump is calling for. So who would the average voter view, as the Fed is a cowtowing to?
Speaker 1:Yeah, certainly both sides could message that. Definitely, guys, what else is on your radar when you think about the next week?
Speaker 2:Long weekend right.
Speaker 1:Oh, that's. How could I forget? How could I forget? What's on my mind is the three-day weekend Absolutely. I'm doing my taxes on Monday, so it's going to be a real exciting weekend for me. Great, well, that does it for us today on the Macrocast. I do want to let our listeners know one more thing that we want to share with you. We are planning to make some changes to the Macrocast, and next week will be the last episode in its current form. We're going to let you know more about our plans soon, so tune in next week as we reflect on all the twists and turns of the economy that we've talked about over the years and look ahead at what's to come. We hope you will join us, but for now, I'm Elan Moy with PENTA, thanks to my co-host, brendan and John of Market's Policy Partners. Thank you for listening and remember that you can always subscribe to the Macrocast wherever you get your podcasts. Have a great day.