They called 'peak inflation' 3 times in the '70s. Just saying. They called 'peak inflation' 3 times in the '70s. Just saying.\images\insights\article\grocery-shopping-man-small.jpg April 28 2023 February 17 2023

They called 'peak inflation' 3 times in the '70s. Just saying.

Inflation, consumer strength move bonds closer to the Fed. Stocks still keeping some distance.

Published February 17 2023

Traveling in frigid Sioux Falls, which absolutely is not having a mild winter, with snowfalls piling up to No. 6 in the city’s history and potholes that would make Pittsburgh roads blush. My local coworker hit a big one, no flat, but 2-3’ in diameter, inspiring him to call the mayor’s office. Next day, fixed. Class acts here in South Dakota. Agriculture is the state’s largest industry with major crops including soybeans and field corn. Farmers here are nervous as the winter can hit particularly hard in March and April, peak months for planting. No mind, it’s Valentine’s Day, and dinner at the Sioux Falls Country Club was crowded with couples (many wearing red) plus me, my colleague and our local client (we were wearing black). Advisors here are cautious. And at several client events, I was peppered with questions about the state of the economy and stock market. Seems everyone wonders what to make of this market. On the one hand, bonds are moving toward the Fed. The 2-year Treasury yield has shot up 52 basis points since the last Fed meeting; the 10-year yield is up 45. On the other hand, equities aren’t just fighting the Fed, they’re taunting it, J.P. Morgan says. Stocks have roughly tread water after January’s rally—S&P 500 resistance in the 4,100s is holding—while sentiment is nearing exuberance. The percentage of AAII bulls is the highest since ’21 and the CNN fear-greed index is at extreme greed. Retail volume is close to a record high (more below) and leadership is upside down, with crypto, memes and lower quality stocks at the top.

At what point do valuations and a higher-for-longer Fed trajectory collide? This week’s CPI and PPI reports (more below), along with revisions to last year’s seasonal factors, gave no reason for Fed hawks to back off. The data suggests disinflation in ’22’s waning months was overstated and nascent improvement this year is stalling. The 3-month annualized change in core CPI is now 4.6%, up from December’s 4.3% and more than twice the Fed’s objective. The details are worse. A lessening of used-car deflation—prices in fact are rising again—has yet to be reflected in the inflation numbers. And last month’s price gains were broad-based. The Cleveland Fed’s trimmed mean CPI, which eliminates outliers on both ends, posted its highest reading since September, and year-over-year (y/y) median CPI was the highest in that series’ 40-year history. If temporary Covid-affected price swings are excluded, underlying core CPI inflation has only slowed from its 6% 3-month annualized peak in early 2022 to 5%, according to Applied Global Macro Research calculations. To be sure, housing inflation—which played a major role in January’s surprise—looks set to fall from its 9% peak to 5% this year. Market rents that determine the component are rolling over. But other large service sectors are just starting to reflect the past year’s wage increases, and labor costs overall are still running at about 4-4.5% annualized. Tough week for the doves.

With neither the labor market nor inflation behaving as the equity markets may wish, the concern for investors is how much pain might the Fed dish out. The economy is showing little sign of recession, the consensus for ’23 just a few months ago. Indeed, pay raises negotiated last year, cost-of-living adjustments (inflation-index Social Security payments jumped nearly 9% in January) and state tax cuts are feeding consumer spending. Credit cards, too. Revolving credit growth continues to make new highs and as a percentage of disposable income, it is still running below the 6.6% average from 2012-19. Lots more buying power for a consumer who surprised in January (see below). According to government transaction data, card spending currently is running nearly 13% above the pre-pandemic trend. Liquidity continues to be an economic tailwind, too. Even though M2 is now contracting y/y, it still stands $4 trillion above its pre-Covid trend. The animal spirits of the consumer may be well underappreciated (more below.) And with Strategas Research saying downward wage pressure is sticky, the wage-price spiral that plagued the ’70s (more below) is a distinct possibility.


  • Good news is bad news Retail sales surged broadly and unexpectedly in January, led by a 7.2% monthly jump at eating and drinking establishments. Headline sales rose 6.4% y/y, and core sales blew through consensus. Consumer spending’s on track to rise 4% in Q1, a problem for the Fed, with futures now pricing a 5.5% terminal rate by summer.
  • Manufacturing surprises January factory production rose 1%, beating expectations, as durable, nondurable and other manufacturing activity rose. Overall industrial production for the month was unchanged, as unusually warm weather slashed utility demand. Initial New York and Philly gauges of February manufacturing were mixed, with the former improving and the latter deteriorating.
  • Housing may be eking out a bottom January housing starts fell more than expected but not enough to reverse December’s big rise, keeping the 2-month pace well above forward-looking permits, which have fallen more dramatically. Separately, the NAHB confidence gauge rose a second straight month to its highest level since September as expectations, sales and buyer traffic all improved. The latest weekly mortgage purchase applications fell, reversing the prior week’s increase, but remain up for the year.


  • Bad news is bad news January CPI and PPI reports showed inflation hanging tough, with headline and core y/y CPI coming in above consensus and just a tick below December. Headline and core y/y PPI came in well above consensus, too, albeit again off December levels, indicating further price improvements may come slowly. Indeed, month-over-month PPI readings were above December figures. While January import prices were much weaker than expected, the consumer goods ex autos component firmed, an upside risk to core goods CPI, which had been decelerating.
  • Wage-price spiral The share of small business owners reporting job openings they could not fill rose to 45% in January, nearly double the NFIB survey’s 49-year average. A net 46% said they’ve had to raise compensation to overcome their top operating problem, a tight labor market that’s affecting quality and costs. Another 22% said they plan to take similar steps in coming months.
  • Breathtaking fiscal largesse  The nonpartisan Congressional Budget Office forecasts U.S. debt to GDP to rise rapidly above already record levels over the next 10 years—$3.4 trillion of new deficits have been added since just last May! You’ve never seen spending like this outside of a recession. Consequently, it projects three trust funds—Medicare, Social Security and Old Age & Survivors Insurance—to run out of money. Fiscal austerity may be forced on both parties who insist Medicare and Social Security won’t be touched.

What else

A 99th+ percentile event From Jan. 31 to Feb 15, short covering in U.S. tech was the second-largest in magnitude over any 12-day period in the past decade and ranked in the 99.5 percentile (only the period from late January to early February ’21 saw more intense short covering by hedge funds amid the meme frenzy).

A 99th+ percentile event Wednesday was “the most intense retail day ever,’’ Bank of America says, with explosive outperformance of retail trading names versus the market. While it’s hard to predict the end of this wave of retail investor speculation, a strong signal to chase lower is when more puts versus calls are traded. That hasn’t happened, yet.

Gambling not just in the memes Las Vegas gaming revenue jumped 10.5% y/y, the strongest since 1999 (excluding 2021 given comps to a pandemic-riddled 2020) and the highest total on record. Relative to 2019, the growth was an even higher 23%, almost double 2021’s 12% jump over the pre-pandemic year.

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Tags Equity . Fixed Income . Markets/Economy . Monetary Policy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Cleveland Fed median CPI: A monthly survey by the regional Federal Reserve bank that seeks to capture underlying inflation trends.

CNN's Fear and Greed Index measures several indicators of investment sentiment.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

M2 is a broad measure of money supply that includes not only cash and checking deposits but also easily convertible "near money" such as savings deposits, certificates of deposit and money market securities.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

The American Association of Individual Investors (AAII) Bulls Minus Bears Index is a measure of market sentiment derived from a survey asking individual investors to rank themselves as bullish or bearish.

The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.

The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.

The National Association of Home Builders/Wells Fargo Housing Opportunity Index reflects the percentage of households with median incomes that could afford new homes at median prices.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

Federated Equity Management Company of Pennsylvania