Highway To The Danger Zone
It's been an action-packed week despite the holiday. Both measures of inflation, PPI and CPI, were released this week and continued to move higher in March. There's talk about the U.S. hitting "peak inflation" at some point this year, but we're not convinced that's the case.
At this point, we're getting into some uncharted territory - at last in the last 40 years. In honor of the release of "Top Gun: Maverick" in the coming months, I feel like we're on a "Highway To The Danger Zone." Right now there is a lot of pointing fingers and a lack of willingness to address inflation that has us on a dangerous path. Here's what we're seeing so far this week...
Inflation - "I Feel The Need...The Need For Speed!" This week, the March release of the Consumer Price Index came in as expected, but much higher than February's print.
The Producer Price Index, however, came in hotter than expected. CPI moved higher by 1.2% in March, taking the year-over-year tally to +8.5%. PPI moved higher by 1.4%, taking the year-over-year total to +11.2%. We've discussed on previous blog posts how CPI does not typically peak until PPI peaks and moves lower. We have not seen this fast of an increase in inflation in more than 40 years. March makes the 15th consecutive month that PPI has increased, with no signs of a peak. In fact, the gap between PPI and CPI has broadened over the last four months. Until that gap is reduced, there's no sign inflation will peak in the near term. The reason inflation doesn't look to peak is that producers still have costs to pass along to consumers as long as PPI is increasing.
One example is the 5% fuel and inflation fee recently announced by Amazon. The surcharge will apply to sellers who use Amazon's network of fulfillment centers. I wonder who will pay those fees down the line...I'm thinking it will be consumers. If that was not bad enough, the price of oil, which had declined from March highs of $114/barrel, exploded higher around mid-day after a report indicated the EU was prepping a Russian oil embargo. The gap between wage growth and inflation continues to widen. Just 6 months ago, the gap between rising inflation and wage growth was only 0.9%. After March CPI was released earlier this week, the gap has now widened to 2.9% - a 3x increase!
The Yield Curve - "Because I was inverted." Last week we laid out how the yield curve had inverted. The yield on the 2-year Treasury Bond had exceeded the yield on the 10-year Treasury Bond at the end of March, but had not officially closed inverted.
That happened on April 1st. However, the inversion was extremely short-lived, lasting only 2 days. This is very similar to 2019 when the curve inverted for only 3 days. Since April 1st, the yield curve has steepened dramatically and the two bonds are now 36 basis points apart. I don't know that there are any concrete conclusions to draw from this particular inversion, as so many other landmines are out there - inflation, Ukraine, etc. As we have previously stated, on average, there is a 13-month lag time between when the yield curve inverts and when recessions occur. The inversion of the 3mth T-bill and the 10-year Treasury yields is a more imminent sign of recession on the horizon and those two are still more than 200 basis points apart - not having inverted since February of 2020.
The Consumer - "Any of you Boys seen an aircraft carrier around here?" As long as the consumer continues to spend, economic growth is likely to follow.
The Fed is counting on this for a "soft-landing" of the economy in their fight against inflation. With the amount of money that the government and the Fed have pumped into the system, demand continues to remain strong. Retail Sales for March were released this morning and the number was just slightly lower than expected, but still positive. In fact, year-
over-year, the growth is +6.8%. For some perspective, in the months prior to the pandemic, the year-over-year growth in Retail Sales was averaging +3%. So far, the consumer does not appear to be weary, but this is something we will have to watch closely over the coming months. One area of concern is the decline in mortgage applications. The interest rate on a 30-year mortgage has nearly doubled since August of last year. Mortgage applications have declined each week for the past 5 consecutive weeks. We'll need to also monitor large purchases. In the latest report, spending online declined in March, but furniture and appliance purchases increased month-over-month.
The much anticipated release of "Top Gun: Maverick" was delayed due to the onset of the pandemic. The anticipation of another recession may be delayed as long as consumer demand remains high. A hawkish Fed and supply issues could bring on a recession faster than expected. Time will tell.