February 13 – Stock futures came under pressure as the inflation data rolled in this morning, while the dollar index followed Treasury yields higher. The VIX firmed to trade near 15 as the above unfolded, with the dollar index trading at three-month highs near 104.8. Yields on 10-year Treasuries popped to fresh two-month highs to trade near 4.27% following the inflation data this morning, while yields on 2-year Treasuries surged to fresh eight-week highs to trade near 4.60%. Crude oil prices remain modestly higher on Middle East geopolitical risks, although prices pulled back a bit on the CPI data, while the grain and oilseed sector traded mixed to weaker overnight.
The headline consumer price index rose 0.3% month-on-month in January, matching the previous month’s level, but coming in above analyst expectations that it would slip to 0.2% growth. The headline CPI rose 3.1% year-on-year, down from 3.4% the previous month, but still above analyst expectations of 3.0%. The core CPI, that excludes the more volatile food and energy prices, rose 0.4% month-on-month in January, exceeding the previous month’s 0.3% pace, and exceeding analyst expectations of 0.3%. The core CPI was up 3.9% year-on-year in January, matching the previous month, but above analyst expectations that it would slip to 3.7%.
Energy prices actually fell in January, offsetting increases in other areas, raising concerns about what happens if a strengthening economy and/or escalating tensions in the Middle East push energy prices higher. The crude oil market is slowly trending upward toward the $80 per barrel that it hasn’t traded for several months. As for today’s data, it shows that energy prices fell 0.9% month-on-month in January, marking the fourth consecutive month of declines, and putting them down 4.6% year-on-year. The trend for energy prices thus far for February is higher, but we’ll see how that holds the rest of the month. Gasoline prices fell 3.3% on the month in January, while fuel oil dropped 4.5%, although natural gas prices rose 2.0% in January. We also saw month-on-month declines for used cars (-3.4%), apparel (-0.7%), and medical care commodities (-0.6%).
But transportation costs surged 1.0% on the month in January, putting them up 9.5% year-on-year. Another problem area is shelter costs, where inflation is gaining momentum once again. Shelter costs rose to a four-month high 0.6% gain on the month, and up 6.0% year-on-year. Medical care services rose 0.7% month-on-month, and food away from home rose 0.5%, with the latter now up 5.1% year-on-year. These core inflation areas are of concern to the Federal Reserve, and we haven’t yet mentioned the labor component of this, with wage inflation still a factor as well that contributes to much of the above. Inflation remains sticky for wages and shelter. Surging consumer sentiment does little to ease those concerns in either category. The economy remains resilient, showing ongoing signs of growth. The Federal Reserve has little incentive to cut rates as long as these sticky areas of inflation remain, and the economy remains solid. We’ll get key data on retail sales, weekly jobless claims, manufacturing, and on the housing market on Thursday, with the producer price index coming out on Friday, along with housing starts. The end of the week will be critical for setting the tone going into next week.
Crude oil prices crept higher overnight, continuing a trend seen over the past week plus of adding risk premium to the market tied to escalating geopolitical risks in the Middle East. OPEC released its monthly report today, calling for an increase in global demand of 2.25 million barrels per day this year. Its demand estimates continue to be on the high side of the industry as it tries to encourage continued participation in output quotas from its members. The fear of OPEC losing control of its members due to decreased revenues continues to limit the upside potential of the crude oil market, as well as sluggish economic growth in China. That could change if China would finally come forth with a meaningful stimulus package and/or if we were to see a spread of the war in the Middle East in a way that would strike at oil production and shipping infrastructure. Adding higher crude oil prices above $80 per barrel to the above core inflation data would present some problems for the Federal Reserve. Now add in the rising supply of Treasury notes being offered on the market (averaging up 23% across the curve) due to Congressional spending, and it becomes difficult to see an environment of low interest rates once again any time soon. The only scenario that I see that supports significant interest rate cuts this year would be one in which the economy shows a more significant decline. The Federal Reserve might still need to worry about the long end of the yield curve going up amid the increase supply of debt certificates being dumped onto the market, unless the Treasury market can attract a large volume of purchases from the Baby Boomers and pension plans.
