Happy Valentine’s Day!

Love may be in the air, but interest rates didn’t get much love after this week’s big inflation report.

• Federal Reserve (Fed) Chairman Powell had his semi-annual testimony to both chambers of Congress this week.
  
• Two important inflation reports: Consumer Price Index (CPI) and Producer Price Index (PPI) for January came out with a whipsaw to rates. 
  
• The US Treasury had some important bond auctions. 
  
• Retail Sales numbers were rate-friendly on Friday.

Fed Chairman Testimony: The Economy is Still Strong

During Fed Chairman Jerome Powell’s two days of testimony this week, he indicated that the economy is still strong. Inflation is making progress towards the Fed’s goal of 2% of Core Inflation (stripping away volatile food and energy prices). The labor market remains strong but is no longer overheated as it was after Covid.

Powell didn’t indicate any hurry for further rate cuts but could change his mind if inflation were to drop quickly or the labor market showed signs of significant weakness. He seems to be ignoring the demands for faster rate cuts from President Trump by continuing to state that future rate cuts will be data dependent.

Something interesting Powell said was that there could be challenges in the future to home buyers in states like California and Florida if they can’t obtain insurance in the future.

Inflation Surprise: CPI Spikes, PPI Eases Fears 

CPI was brutal on Wednesday. Market analysts largely agreed that they expected inflation to be tame in January’s report. 

Coupled with a larger replacement from the previous year, expectations were for more progress towards the Fed’s 2% goal. Instead, we saw these results:

• Headline inflation rose .5% MoM with expectations at .3%. YoY showed an increase from 2.9% to 3.0%, also above expectations. Large increases in energy and food led this increase. 
• Core inflation rose MoM as well by .4% vs .2% as expected. YoY Core inflation rose from 3.2% to 3.3% also beating estimates of a fall to 3.1%. Motor Vehicle Insurance, Used Cars, and Shelter were the main causes.
• Both Motor Vehicle Insurance and Used Cars rose 2% in one month. Shelter was expected to show progress towards “real” numbers (without the lag), as we have discussed repeatedly. The Bureau of Labor Statistics hurt that by revising last year’s Shelter number lower making the replacement value less than expected. 
• Inside of Shelter, Lodging Away From Home rose by 1.4%. This volatile subset of Shelter has huge swings that are unpredictable. 
• This report led to interest rates increasing about .25% intra-day.

Thankfully, PPI came out the next day and we saw markets swing fully back to where they were prior to CPI. CPI tracks prices that consumers pay, while PPI tracks wholesale prices that producers pay before deciding what to pass on to consumers. Several components of PPI are the same as Personal Consumption Expenditures (PCE), the Fed’s favorite inflation report. PPI can give us a good preview of what to expect from the PCE report coming out on February 28^th. 

• Headline PPI for January came in at .4% vs. .3% expected and YoY it remained at 3.5%.
• The Core PPI was .3%, the same as estimated, and YoY it fell from 3.7% to 3.6%.
• One large increase was wholesale egg prices, which rose 44% in one month due to the Avian Flu. 
• Two components that showed declining prices were Healthcare and Airline Passenger Services. Both of these are found in PCE.

 
Treasury Auctions Steady, Gold Revaluation Eyed

The US Treasury had 10-year and 30-year bond auctions. Both had only modest demand but not bad enough to negatively impact rates.

One interesting proposal that came from the US Treasury indicated that they may revalue the gold owned by the government from $42/ounce to current rates of $2900/ounce. This increase in value would cause the balance sheet of the Treasury to increase by hundreds of billions of dollars and allow less debt to be issued. Less supply, albeit temporary, would allow rates to decline.

Retail Sales Slump: Consumers Hit Spending Limits

Retail Sales came in significantly worse than expectations indicating that consumers are tapping out their credit appetite to buy things.

• In January, Retail Sales fell .9% when markets were only expecting a .1% decline. This was the largest single-month decline in two (2) years.
• Core Retail Sales fell by .8% vs .3% expected.
• Credit Card Debt hit $1.2 Trillion, which is 41% higher than pre-Covid levels.

Once consumers reach their credit spending limits, they will not be able to continue to purchase. This, coupled with interest rates in the 20%+ range, makes things tight for consumers. Remember, one of the most important parts of GDP (Gross Domestic Product, or the nation’s income) is Consumer Spending. Retail Sales is highly indicative of Consumer Spending. These numbers were great for lower interest rates.

Looking Ahead

Next week, markets are closed on Monday for the President’s Day holiday. Here’s what to keep an eye out for the rest of the week:

Tuesday, February 18

• Empire State Manufacturing

Wednesday, February 19

• Housing Starts
• Building Permits
• Fed meeting minutes are released

Thursday, February 20

• Jobless Claims
• Crude Oil Inventories

Friday, February 21

• Existing Home Sales
• University of Michigan Consumer Sentiment

The next big report will be Personal Consumption Expenditures (PCE) on February 28.