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March Inflation: In Like a Lion; Out Like a Lamb

The CPI came out on Wednesday – it only rose +0.1% in March – that’s down from +0.4% in February and +0.5% in January. On a Y/Y basis, it fell from +6.0% in February and +6.4% in January to +5.0% (see table).

CPI actually rose only +0.053% to the 3rd decimal (about half as much as the +0.1% reported). Because the media only reports to one decimal, it is rounded up or down. In this case, +.053% is rounded up to +.1%. If it were +0.049, it would have been rounded down to 0.0%.

On Thursday, the Producer Price Index, PPI, really shocked to the downside. It fell -0.5%; the markets were expecting no change. And if we look at core PPI (ex-food and ex-energy), it only rose +0.1%, while the consensus was for a rise of +0.3%. The Y/Y headline number was +2.7% vs. +4.9% in February. This was the softest reading since all the way back to January 2021. Over the past year, the core rate fell to +3.6% from +4.1%.

Crude material prices in the core PPI showed up as -13.5% from a year earlier (was +26% in March 2022) while core intermediate materials showed up as 0% (these were rising at a 19% rate a year ago). Service sector PPI deflated -0.3% M/M, the first decline since November 2020. Since the Fed is fixated on service sector inflation, this is good news, implying softer service sector inflation going forward.

Back to the CPI, the low number occurred with the shelter component at +0.6%. And while this is the lowest shelter in the CPI report since April 2022, we know from private sector sources (Zillow) that rents continue to contract.

Shelter has a weight of about 33% in the CPI calculation. Rents are falling. For illustrative purposes, if we assume they didn’t rise, i.e., 0%, then the monthly change in the CPI would have been negative (-0.17% rounded to -0.2% for the media). The yearly rate would have fallen to +4.76% from the 5.0% now being reported. 

Shelter costs are falling, as is apparent from the chart below. This is due to rising vacancy rates as record levels of new apartments come online. Let’s pick something realistic; let’s say that rents fell -0.5% in March. If that were the case, CPI would have been -0.28% (i.e., -0.3% for the media) which annualizes to -3.3%.  Finally, if we look at the CPI components of the PPI, on a Y/Y basis, the rise was but +2.7%. So, you see, from both the CPI and PPI reports, we appear to have entered the initial stages of deflation.

Impact on the Fed

Unfortunately, the Fed isn’t looking at the headline rate. It looks at service inflation (for example, airline fares rose +4.0%, and hotels/motels rose +2.7% in March alone). Overall, their go-to gauge (core services ex-energy ex-rent) rose +0.4% in March and is showing the same increases that it has shown since last August. The Y/Y number here is +5.8%. A year ago, this was +4.8%. So, they will likely raise +25 basis points (+0.25 pct. points) on May 3rd. But expect a dovish statement and press conference. If the latest price trends continue, as we expect, this will be the last rate hike.

Those Pesky Bank Runs

There are still some “Nervous Nellies” in the financial markets regarding the Regional Banks. On Wednesday, April 5, the stock price of one of the major Regionals (WAL) got trashed simply because, in a press release by the bank, the deposit data wasn’t detailed enough. Nerves calmed later in the day when the bank updated its press release to show it had sufficient liquidity and that the deposit base had stabilized. We don’t expect a repeat of that scenario, as other Regional Banks now know what the market wants to see regarding press releases.

And while most of the panic from the mid-March bank runs seems to have dissipated, we caution that most of the real fallout lies ahead as banks move into restructuring mode. This will only serve to deepen the Recession.

To survive the deposit runs in March, except for the money center banks, there has been significant borrowing from the Fed (more than $350 billion) at a near 5% rate, with the pledged collateral yielding quite a bit less (most of it bonds purchased pre-2022 when rates hugged the zero line). Profit margins will surely suffer.

In addition, banks were already tightening credit before the Silicon Valley Bank fiasco and are now tightening even more as issues in Commercial Real Estate (CRE) loom. (The financial press is littered with articles regarding empty office buildings and oncoming issues in CRE.) The chart shows a large percentage of CRE loans on small bank balance sheets. As a result, banks will be building their loan loss provisions, tightening credit, and paying higher interest rates to keep their existing deposit base.

Lower bank profits, tighter credit, and higher loan losses point to much lower credit availability to the economy. In the four weeks that ended March 29th, outstanding credit has contracted at a -3.4% annual rate, commercial and industrial loans at a -18.6% rate, auto loans at -5.4%, and real estate loans at -3.4%. Recession, you say!

Incoming Data is Tanking

For several months we have been chronicling the emerging negative trends in the economy. All at once, March’s incoming data show large negative postings.

  • The Department of Labor (DOL) appears to have gotten religion. For months we have been scratching our heads regarding the continued low level of jobless claims in the face of large layoff announcements. We postulated that the low level of jobless claims was caused by the WARN Act, which requires 60 to 90 days from layoff announcement to actual head cuts for larger businesses cutting more than 50 jobs. We believe this continues to occur. Last week, however, the Department of Labor came out with revised jobless claim estimates. Seems that back in 2020 they had changed their seasonal adjustment methodology to compensate for COVID. The chart above shows what has occurred by changing back to pre-COVID techniques, i.e., +50K in the latest weekly data, a 26% difference. Suddenly, the “hot” labor market appears to have cooled.
  • The IMF has trimmed its forecast for world economic growth to 2.8%. Last year the call for 2023 was 3.4%, so quite the reduction. Note from the chart above the precipitous drops in consumer confidence in Europe and China (even in the wake of re-opening)!
  • In the U.S., after rapidly rising for most of 2022, credit card spending appears to have hit a brick wall, as seen in the chart below. Most retail giants have recently noted that consumers have been “trading down,” meaning looking for cheaper alternatives (i.e., store brands, do-it-yourself projects, etc.). Note from the right-hand side of the chart the rapid plunge in credit card usage over the past quarter.
  • Retail sales fell 1.0% in March on top of February’s -6.6% drubbing. Gasoline sales were off -5.5%, most of which was price related. Building material sales fell -2.1%. Given the weakness in housing, the latter isn’t surprising.
  • Manufacturing output was down -0.5% in March. For Q1, it appears that such output will show up as +0.3% (annual rate). However, the number for March indicates a negative handoff for growth going into Q2. Mining output fell -0.5%, wood, and non-metallic materials crashed -3.0%, motor vehicle production was down -1.5%, while fabricated metals, machinery, and computer production each declined -1.0%.
  • Leading Economic Indicators (LEI) has been negative for 11 months in a row and flat or negative for 13 of 14. That’s never happened before without a Recession.

Money Supply

Most economists know how important growth in the money supply is both to economic growth and inflation. Strangely, the media’s coverage of the monetary aggregates is skimpy at best. The contraction we are now seeing in those aggregates is of historic proportions.

  • M1 (cash + demand deposits) fell -1.2% in February (latest data), has fallen 11 months in a row, and is down -5.8% over the past year.
  • M2 (M1+ time deposits) fell -0.6% in February. M2 has fallen for seven months in a row, and over the past year, it has fallen -2.4%. This is the lowest number in the history of the series, which goes back to the 1950s. A year ago, M2 was sporting a +10% rate. The chart above shows a growth rate in excess of 25% in 2021, as the Fed accommodated the fiscal response to COVID, clearly playing a crucial role in the inflation of the past couple of years. The negative growth in M2, however, is just one more sign that deflation/Recession is in the future.

Final Thoughts

As the Recession unfolds and deflation becomes the order of the day, the Fed will respond as all past Feds have. A move up in rates of +25 basis points in May, if that comes to pass, will be the last of this rate hiking cycle. We’ve now seen three FOMC members, Goolsbee (Chicago), Harker (Philadelphia), and Daly (SF), indicate that they would like to see a “pause” to allow the Fed’s prior actions and the post-Silicon Valley Bank credit tightening to work their way through the economy. (Perhaps the rate hike won’t have a unanimous vote.)

Looking further down the road, the Fed’s view of a neutral Fed Funds Rate (where Fed policy is neither tight nor easy) is +2.5%. We are currently at more than +5%. Historically, in a Recession, the Fed has always moved rates to the easy side. It is -2.5 pct. points to get to neutral. As a result, we can conceive of a 2-Year T-Note near 1% again (currently 4.1%) and the 10-Year around 2.25% (currently 3.52%) sometime in 2024.

Robert Barone, Ph.D.

(Joshua Barone and Eugene Hoover contributed to this blog)


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