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The Fed Wins – Rates Higher for Longer

The Implications

This week, there were three major data releases – the Consumer Price Index (CPI), Retail Sales, and the Producer Price Index (PPI), all for January.  The CPI met expectations, rising +0.5% for January. The Retail Sales number at +3% beat the consensus estimate of +1.9%, and PPI came in a little hot.

Markets “Throw in the Towel”

At January’s end (blue bars in the chart), markets had priced in just one 25 basis point Fed rate hike in March and then a 25 basis point rate cut late in Q3, followed by another one late in Q4. But then something happened! By Friday, February 10, markets had “thrown in the towel” on their view that the hawkish tone of FOMC members was just for show. The orange bars show market views as of Friday, February 10, before those data were released. Even before the CPI release on February 10, market views were more in line with the Fed’s December dot plot and Powell and FOMC rhetoric.


As reported on Tuesday (February 14), at +0.5%, this was the highest CPI print since July. At first, markets took the CPI data in stride as the year-over-year rate fell to 6.4% from 6.5%. In addition, there initially appeared to be some good news in that core services ex-housing, a focus of the Federal Open Market Committee (FOMC)(or at least a focus of Chair Powell), came in at +0.36% (a +4.4% annual rate), below last year’s +0.5% monthly average.

Unfortunately, the Producer Price Index (reported on Thursday, February 16) at +0.7% was also hotter than market expectations, reinforcing the markets’ new view of higher rates for longer.

The rent calculation in the CPI is several months behind reality, as rents have been falling for several months. The rent portion of the CPI rose +0.7% (i.e., +8.7% annual rate) in the January release. Taking the high weight of the shelter component (>30%) into account, if we assigned no change to that component, the overall CPI would have shown up as +0.3% (+3.66% annual rate). And, if the rents component mirrored reality, even falling just -0.1%, the overall monthly CPI would have been +0.19% (+2.3% annual rate). Despite the minor setback in January’s inflation data, disinflation shows up when up-to-date rents are considered.

Retail Sales

On Wednesday, February 15, The Commerce Department reported a 3% jump in January’s Retail Sales, which showed up as -1.1% after December. Markets were expecting +1.9%, so this was an upside surprise. But beneath the surface, things don’t look so good. This is a Seasonally Adjusted number. Looking at the Not Seasonally Adjusted (i.e., the raw data) leads to confusion. Remember, the Bureau of Labor Statistics turned January’s -2.5 million job losses (the raw data) into a +517 thousand gain via the magic of Seasonal Adjustment. This was also true for Retail Sales.

The chart shows that the Not Seasonally Adjusted change in Retail Sales (i.e., the “raw” data) fell by over $100 billion in January. Like the Payroll data, it was only by the magic of Seasonal Adjustment that this became +$20 billion.

The Seasonally Adjusted Payroll data, and now Retail Sales, have convinced both the market and many economists that, despite much evidence to the contrary, the economy will either have a “soft landing” or “no landing” (i.e., no Recession) whatsoever. And the Seasonally Adjusted Retail Sales, along with the Payroll numbers last week, give the Fed plenty of justification to continue to raise rates.

As noted above, the chart at the top of this blog shows the markets’ perception of the Fed Funds rate for the next 12 months. The blue bars represent market perceptions on January 31, the orange bars on February 10, and the gray bars as of February 15, after the Retail Sales Report. Note the following:

  • The expected terminal rate has risen from about 4.9% at the end of January to 5.25% as of mid-February, now in line with the Fed’s December dot plot.
  • Rate cuts from 4.9% to 4.25% beginning in Q3, (the January 31 expectation (blue bars)) have now morphed into one small rate cut at year’s end (gray bars).
  • By January 2024, rates are expected to be nearly 75 basis points higher than markets foresaw just two weeks ago (the difference between the gray and blue bars as of January 2024).

Despite what appears to be quite “upbeat” Seasonally Adjusted Payroll and Retail Sales data for January, we find it hard to get excited about an actual loss of more than -2.5 million jobs and -$100 billion lower level of Retail Sales (Not Seasonally Adjusted data). There is little corroborating data to support the “soft landing”, and “no recession” narratives.

  • Layoff announcements continue with Challenger’s year-over-year layoff announcements up more than 400%. The list of major company layoffs continues to grow, including Amazon, Microsoft, MMM, Blackrock, Google, Disney, and IBM…
  • Within the Household Survey, there has been no increase in full-time jobs since last May; the increase has been in the lower paying, no benefits, part-time area.
  • The Conference Board’s Leading Economic Indicators have been down ten months in a row and 11 of the last 12. Such a pattern has never occurred without a Recession.
  • Inverted Yield Curve: One-Year Treasury yields are higher than any longer maturities. An inverted yield occurs when short-term rates are higher than long-term rates. An “inverted” yield curve is also a reliable Recession indicator, especially if such a condition has longevity. The 2s/10s inverted last June; now even the 3-month yield is higher than the 10-Year. The Fed has signaled that they will raise the Fed Funds rate another 50 basis points by early May (and the fixed-income markets have capitulated). This will make the inversion even steeper.
  • Housing starts and building permits fell at annual rates of -21% and -47% in Q4 and continued their downtrends in January. Mortgage applications are off by 58% over the last 12 months. Home prices have fallen at a -9.7% rate since the middle of last year. (In Canada, home prices are off -19%!)
  • Cargo activity at U.S. ports has weakened significantly. At Long Beach, cargo activity is off -28% from a year ago, and it’s off more than -7% at the Port of L.A.
  • New business formation is off -2.3% over the last 12 months, making a mockery of BLS’s Birth/Death model, add of more than a million jobs to 2022’s Payroll data. (Since they don’t survey small businesses, BLS adds a number to monthly Payrolls based on a long-term trendline of small business formation – called the Birth/Death model – never mind current conditions!)
  • We have seen reports of trouble in the REIT space, where large office buildings have gone into foreclosure. Rising rates and a slowing economy will only intensify this phenomenon.
  • Consumer debt rose +8.3% in 2022 to a record $16.9 trillion. Credit card and auto loan delinquencies are rising. The left side of the chart shows weakening demand for all the major loan classifications, including business loans (C&I), auto loans, and especially mortgages. The right side of the chart shows that banks are tightening credit standards. We expect demand to get even weaker as interest rates continue to rise.
  • Bulk shipping costs have fallen nearly -80% from their pandemic highs and are now below their pre-Covid levels. Freight volumes are off -4% from year-ago levels.
  • The Industrial Production Index is off -1.6% since October (a -5.3% annual rate). Its Manufacturing sub-index is off even more.

Final Thoughts

The Fed looks to continue to raise interest rates based upon what appears to be better than expected Seasonally Adjusted Payroll and Retail Sales data. The underlying (raw) data are shocking, and it is challenging to find corroborating evidence that the economy is strengthening. 

Perhaps the pandemic changed business attitudes toward hiring, as throughout most of 2022, finding employees was difficult. It is plausible that employers are moving their excess employees to part-time status rather than laying them off. After all, 100% of the job gains since May has been part-time! Over time, such an attitude change will appear in the seasonal factors. Let’s not forget that in January, the raw data showed -2.5 million fewer jobs, but the seasonal factor turned that into +517 thousand. If we are correct about business attitudes, then future revisions will significantly lower the +517 thousand January Payroll number as the seasonal factors catch up to those new attitudes (but, by then, no one will care). As far as Retail Sales are concerned, we note that November and December sales were negative. We also note that, at that time, there was unwanted inventory. Perhaps retailers had more inventory clearance sales than usual. The difference between the +3.0% Seasonally Adjusted growth in such sales in January vs. the +1.9% market expectation is a minuscule alteration in the seasonal factor!

For us, the majority of the incoming data still points to the Recession. And the expected two additional Fed rate hikes in March and May only reinforce our view. Let’s not forget that monetary policy acts with relatively long lags; so much of the Fed’s 2022 tightening has yet to be transmitted to the economy. As we’ve commented in past blogs, the negative growth in the monetary aggregates is also troubling. And now, as delinquencies rise, banks are lending less and tightening lending standards, which is not a good sign for an economy whose growth depends on credit.

Robert Barone, Ph.D.

(Joshua Barone contributed to this blog)


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