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“Hot” Inflation Aberration Will Justify “Higher for Longer” Recession Becomes Highly Likely

The Consumer Price Index surprised markets to the upside for January, growing +0.3% for the month. The consensus estimate was for a +0.2% rise. That puts the most watched year/year CPI number at 3.1%, and while it fell from 3.3% in December, markets were looking for a number with a “2” handle. What deeply disappointed was that “Core” CPI (ex-food and energy) rose +0.4%, the highest since May. This measure of inflation remained at 3.9% over the last 12 months, the same as it was in December. Also disappointing was the “super-core” index (ex-energy services and rents), one which Chair Powell has often referred to. That rose a whopping +0.85% in January, the sharpest rise since April ’22. Its growth over the past 12 months rose to 4.4% from 3.9%.

The major culprits in the CPI were a spike in medical care insurance and medical care services (+0.7%). In addition, auto insurance premiums rose +1.4% on the month and are up more than 20% over the last 12. Making matters worse, the lagged shelter costs rose +0.6% in January (+0.4% in December).

The chart above shows the relationship of the CPI “shelter costs” to BLS’s own New Tenant Rent Index. You can see what should happen to CPI shelter costs over the next few months. The caveat here is that BLS’s OER (Owner’s Equivalent Rent, a large contributor to shelter costs). According to Rosenberg Research, OER is based on a single question in their survey of households (“What do you think you can rent your house for?”). As long as existing home prices stay high (the low inventory of existing homes for sale due to locked in low mortgage rates from the 2012 to 2022 years), homeowners will estimate on the high side. So, the rents calculation may come down more slowly than the chart would otherwise indicate.

On the positive side of the CPI report, without “shelter costs,” the index only rose +0.1% in January, duplicating what it did in December. The rate of growth of this ex-shelter index fell to +1.5% on a year over year basis, down from +1.9% in December, and +5.7% a year ago in January 2023. And if we look at Core CPI without shelter (i.e., ex-food, energy and shelter), it rose +0.2% in January and is up only 2.2% from a year earlier.

What isn’t good is that the “Core” CPI six-month annualized rate rose to 3.6% in January from 3.2% in December. While this isn’t the Fed’s “go-to” index, the CPI is the most visible inflation gauge, and the Fed has to be sensitive to it.

Like its sister price index, the PPI (Producer Price Index) also came in hot for its January reading at +0.3%. The markets were expecting a reading of only +0.1%, so this was considered to be a “big” miss, especially since December’s original reading was -0.1% (which was revised down to -0.2% with the news release). There have been several consequences of these two inflation readings:

  • The Fed will congratulate itself on making the “higher for longer” call. The CPI and PPI readings will certainly solidify that opinion among FOMC members. Whether the “longer” turns out to be even longer remains to be seen.
  • The market odds of a March rate reduction are now a microscopic 10%, and May has fallen to a 30% chance. June is still an eternity away as far as the economy is concerned, i.e., a lot can/will happen. So June isn’t a lock for a rate reduction either.
  • Interest rates, which had fallen in December, have now reversed themselves. Note on the chart that after falling to a low of almost 3.75% last fall, yields reversed direction and the 10-Year T-Note now trades in the 4.25% range.
  • Consumer interest rates, already above 20% for credit cards, spiked higher for mortgages. As of Friday (February 16th), mortgage rates were near 7.25% (per Bloomberg) after having been as low as 6.60% in December.

The “Core” PPI Consumption Deflator, a sub-index that attempts to be a leading indicator for the “Core” CPI rose +0.5%, the fastest pace in nearly two years. The culprit was “services” (+0.6%), spurred on by rising medical costs and auto and health insurance premiums. “Goods” actually deflated by -0.2%.

If we look further back in the PPI chain, Core PPI at the intermediate stages of production rose +0.3% for the month, the first positive number in 18 months. Year over year, however, this version of Core PPI still shows up as deflating (-0.8%).

The good news, naturally overlooked by the markets and the media, is that “core” prices at the crude (early) stages of production deflated by a large -1.7% in January and are down -7.0% from year earlier levels. This will have a significant influence on PPI as we move through the year.

Retail Sales

Retail Sales were quite soft in January, falling -0.8% for the month and negative in three of the past four. Wall Street’s consensus estimate was for a -0.2% print, so quite a miss. On a year over year basis, such sales are up only +2.0% on a nominal basis. Since that is below the rate of inflation, real (inflation adjusted) retail sales fell -1.1% in January and are down -2.4% from January ’23 levels. If we slice and dice the data, we get the following for January (via Rosenberg Research):

  • Auto sales:                               -1.7%
  • Electronics:                             -0.4%   (-0.9% December; -5.2% November)
  • Building Materials:                 -4.1%  (quite a large drop)
  • Health Stores:                         -1.1%   (-1.6% December)
  • Apparel:                                  -0.2%
  • Sporting Goods:                      -0.2%
  • Online:                                                -0.8% (+1.4% December)
  • Gen Merch (Dept. Stores):      0.0%

The “core control” number, a number which feeds directly into the consumption portion of GDP, also disappointed, falling -0.4% in January (the consensus estimate was +0.2%, so a large miss here too).

As noted in past blogs, credit card debt is at record levels, and that does not include the new source of leverage for consumers in the “buy now pay later” schemes in the retail industry (even restaurants!).

The savings rate is at a rock bottom 3.7% level. After having spent the “excess savings” gifts from Uncle Sam last year (Q3 and Q4), the consumer appears to be tapped out as evidenced by rising delinquencies across all consumer lending, even mortgages.

It appears safe to say, after this downbeat retail sales report, that the bullish outlook for Q1 GDP, which now sits at 3%+, is skewed significantly to the high side.


There is always a “canary in the coal mine, and in this cycle, New York Community Bancorp (symbol: NYCB) appears to be playing that role. NYCB was one of the winners in last March’s regional banking debacle (collapse of Silicon Valley Bank, Signature Bank…) as it acquired some $38 billion of Signature Bank’s assets with a helping hand from the FDIC. That acquisition put the bank into a more heavily regulated (via size) banking sector with tougher capital requirements. In Q4, the bank charged off $185 million from two CRE loans, added a whopping $552 million to its loan loss provisions and radically cut its dividend to preserve capital. Needless to say, this was quite a shock to the bank analyst community, none of whom saw this coming. The income statement loss in Q4 was -$252 million compared with an expected profit from the analyst community of +$206 million. It isn’t a wonder why the analysts were “shocked.”

This is an example of what could be fairly widespread as CRE loans come up for renewal. Not only are many of them cash starved and hurting for cash flow, but their interest rates are about to triple or quadruple. Because of the large holdings of CRE loans ($2.7 trillion), especially by the larger regional banks, and because the “work from home” craze that began in the pandemic has continued to have a large impact on office rentals, we think that NYCB’s issues are just the tip of the iceberg. As noted above, consumer weakness in the form of rising loan delinquencies add yet another dimension to the oncoming issues in this sector. Note that because of the developing loan problems in the banking system, credit has been contracting for the past several months.

In his 60 Minutes interview on February 4th, Chairman Powell did recognize emerging issues in the banking space. He indicated that he thought the issues were “under control.” We would add – “until they’re not!” (What else could he say? Just think of the market chaos if he said he saw a spate of foreclosures on the horizon!) As a result, we think it would be wise for the Fed to begin the easing cycle “earlier” rather than “later,” even despite the recent hotter than expected CPI and PPI readings.

Final Thoughts

  • The Fed will use the inflation reports to justify its “higher for longer” policy. We think January’s CPI and PPI were anomalies. The underlying trends are to the downside. The “higher for longer” policy increases the already high risk of Recession.
  • As noted in past blogs, credit card debt is at record levels, and that does not include the new source of leverage for consumers in the “buy now pay later” schemes in the retail industry (even restaurants!). With the Household Survey showing large losses in full-time jobs over the past few months, we think the consumer is tapped out.
  • Economic growth is cooling: Retail Sales: -0.8% in January; Industrial Production: -0.1% (with Manufacturing at -0.5%); contracting hours worked; and falling housing starts. These are going to have significant impacts on the economy and on prices going forward. We continue to believe that it will be difficult for the economy to avoid a Recession.
  • The “hot” inflation reports look more like a January aberration in a longer-term downtrend than the start of a new uptrend.

Robert Barone, Ph.D.

(Joshua Barone and Eugene Hoover contributed to this blog)


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