Economic Reports Continue Conflicting Signals to the Fed

This week’s economic reports for January, on inflation, sales, and housing, are likely to continue the conflicting signals to the Federal Reserve. Measured infllation is not dropping as quickly as hoped, yet the supply side of the economy has been week.

The Week That Was

The State of the Union speech was last week’s main economic event. As I listened to the president, I could not help thinking of the great economist Milton Friedman telling us, “If we put government in charge of the Sahara Desert we would soon have a shortage of sand.”

In his State of the Union address, President Biden called for the government to control our electricity, auto manufacturing, and the price and delivery of health care. What could possibly go wrong?

For those who believe in free markets with only minimal government interference, the economic component of Biden’s State of the Union message was discouraging.

Things to Come

The consensus expectation for today’s core CPI was for 0.4 percent, which would be a 5 percent annual rate. It came in at 0.5 percent, a 6.4 percent annual rate.

The next most important report will be tomorrow’s retail sales report. Sales were down in November and December, so any weakness in January would confirm a serious slowing in demand. However, in addition to reports of a strong increase in jobs, vehicle sales rose 16 percent. These indicators point to a rebound in January sales. We expect a monthly increase of 0.5 percent to 1 percent.

As with retail sales, the manufacturing report has been down in the last two months of the year. We expect the report released tomorrow will show January was the third consecutive monthly decline.

Tomorrow’s Homebuilders’ report for early February is expected to remain close to the 38 reading of December. At 12 points below breakeven, new housing activity remains depressed.

Market Forces

With no significant economic news, investors (traders?) gave back the 3 percent gains from a week ago, leaving stocks where they were two weeks ago.

Interest rates were one key reason for the latest setback. Investors already had digested two more small hikes in the fed funds rate in March and May.

Financial markets now see one or more additional hikes on the horizon, which will slow the economy further. Financial markets react to economic news. Small changes in the monthly inflation report can be viewed as either very good or very bad.

Our inflation estimate is based on the expectation of a significant slowdown in business activity. If upcoming data show more strength, interest rates will rise and stocks will go lower. If the estimates move in the opposite direction, we should expect the opposite outcome.

For the months immediately ahead, expect the back-and-forth for interest rates and stock prices to continue in response to economic data. Although our near-term expectation leans toward higher interest rates and lower stock prices, there is a potential for the economic news to break in the other direction. At present we don’t expect much movement of stocks one way or the other for the near future..

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Outlook

Economic Fundamentals: negative

Stock Valuation: S&P 500 overvalued by 18 percent

Monetary Policy: restrictive