Strong Retail & Wholesale Inflation Data: Don’t Hold Your Breath On Rate Cuts Any Time Soon!

Two-Week Economic Review: Feb. 26, 2024

Once again, we had conflicting economic data during the week of February 12th – consumer and wholesale prices jumped in January, while in the same month retail sales dropped more than expected.  The strong inflation data overshadowed the weak retail sales.  As a result, the market again reset its expectations on rate cuts, which are now more in line with the Fed’s forward guidance of a 75 basis-point rate cut by year end. The data underlying these changing expectations was:

Inflation.  On February 13, consumer prices came in hotter than expected on both a monthly and an annual basis.  According to the Bureau of Labor Statistics, year-over-year, consumer prices rose 3.1%, reflecting increases in service costs, while broader goods and energy prices continued to decline.  Shelter (housing) costs contributed over two-thirds of the overall increase. Excluding food and energy costs, the core CPI rose 3.9% year-over-year.  Excluding food, energy, and housing, the “supercore” CPI rose 4.4% over the past 12 months, up from the 3.9% annual gain in December, which represented the fastest rate of increase since May.

A few days later, on February 16, the Labor Department reported that the Producer Price Index (PPI), (also known as “wholesale” prices, the prices paid to producers), rose in January by 0.5% from the prior month and 2% from a year ago, reflecting increases in service costs.  The January figures were more than was forecast on both a monthly and annual basis, showing the persistent nature of inflation.

Following the hotter-than-expected consumer and wholesale prices, the markets are bracing for this Thursday’s release of the PCE (Personal Consumption Expenditures) inflation index.  The PCE index is the Fed’s preferred inflation measure.  If the PCE inflation comes in higher than expected, it would further solidify the notion that the Fed will hold interest rates unchanged until it is sure that inflation is heading sustainably toward the Fed’s 2% target. 

Retail Sales.  While the inflation numbers are indicative of a strong economy putting upward pressure on prices, the latest retail sales numbers tell a different story.  According to the Commerce Department’s February 15 report, retail sales declined in January by much more than expected.  On a sequential basis, retail sales fell 0.8% in January, more than the expected 0.2% drop.  On a year over year basis, retail sales rose 0.6% in January, significantly lower than the 5.3% annual rise in December. Retail sales showed decreases in key categories, mainly resulting both from consumers tightening their belts and colder winter weather in January putting a damper on spending.  Taken by themselves, the retail sales numbers are an indication of a softening economy leading to reduced inflationary pressures and the possibility of near-term rate cuts.  But as noted earlier, the markets appear to be focusing on the inflation numbers rather than retail sales.  

Survey of Leading Economists.  According to a Bloomberg Survey conducted February 16-21 which included responses from 72 leading economists, the economy is expected to grow by 2.1% this year, up from the 1.5% expected by the economists last month.  The survey panel also predicted the unemployment rate peaking at 4.1% later this year, down from the 4.2% expected in the prior month’s survey. They also expect employers to add more jobs through 2026, and lowered their recession forecast to 40% in the next year – the lowest reading since mid-2022.  Overall, the survey results are modestly optimistic for our economic future, but provide little support to those hoping for substantial interest rate cuts in the near term.

On a concluding note, after the release of the stronger-than-expected inflation data, the stock market fell, and Treasury yields surged across the curve and by 15 to 20 basis points for maturities longer than two years. The market now expects a virtually zero percent chance of a rate cut in March, a 50/50 chance for May cut, and a good chance of one cut in June.

Due to the recent price pressures, however, some investors and economists have started speculating that the Fed’s next policy move will be to raise rates.  Citigroup said that markets would be wise to start hedging for the possibility that the Fed reverts to raising rates after a brief easing cycle. Rate hikes are back in the Wall Street narratives, but we need to be more patient and careful in evaluating economic data.  It’s important to remember that one month’s data does not a trend make.  All things considered, we may have a very bumpy road ahead.

Mark Yoon, CFA CPA
EVP & CFO of Commercial Bank of California

Thomas McCullough
EVP of Commercial Bank of California

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