Financial markets resisted the economic bad news last week, posting minor setbacks amid hopes the Fed will let up on its interest rate hikes.
The Week That Was
Economic reports remain mixed. Overall, they point to a 4 percent annual inflation rate and a slight uptick in economic growth.
January’s CPI was mixed. The total CPI was up 6.4 percent, and core CPI was up 3.7 percent, annualized. The monthly core CPI remains close to the 4 percent rate of the past three months.
January core wholesale prices were up at a 6 percent annualized rate, up from 4 percent over the prior three- and six-month periods. Even with the sharp January increase, core wholesale inflation for finished goods remains at 4 percent.
After declining in November and December, January retail sales were reported up by 2.3 percent. With the sharp January gain, retail sales are up at a 6½ percent annualized rate from the fourth quarter.
The Homebuilders’ survey for early February jumped to 42, well above its low of 31 in December, though still below break-even (50). Homebuilders are less pessimistic than before.
Things to Come
Tuesday, S&P’s advanced early February survey of business activity will provide the most up-to-date insight into the latest business conditions. S&P’s surveys have shown a consistent pattern of negative business activity. This is at odds with much of the other data, which show the economy either flat or experiencing sluggish growth.
A key report on economic strength in January will be Friday’s report on consumer spending and incomes. This report provides the most comprehensive monthly picture of the economy.
The December report showed a significant slowdown in spending and incomes. With January jobs and retail sales up sharply, expectations are for strength in spending and incomes. The key is how much strength. If the gains in this report for January are as strong as other data suggest, it would provide a further setback to higher interest rates and stronger inflation.
Market Forces
Stock prices surged early in the week, then fell, leaving the S&P slightly below its level of the previous week. The rate on 10-year T-Notes moved slightly higher, from 3.74 percent to 3.84 percent.
All signs of faster growth negatively affect financial markets. Most recent data show current dollar spending (GDP) increasing at a 6 percent to 7 percent annualized rate. This is inflationary.
We still believe the signs of strength in January are temporary. Our shipping business contacts confirm a slight pickup in January followed by a major reversal in February. If that is correct, we will soon see signs of a slowdown.
Inflation moved higher in January, consistent with our expectation of inflation in the 4 percent vicinity. As the economy weakens, inflation should continue to recede slowly.
For the coming months, expect more back-and-forth moves in interest rates and stock prices in response to unfolding news.
Near-term, expect a further upward drift in interest rates along with lower stock prices. Even so, there is a potential for the economic news to break in the other direction.
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Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 18 percent
Monetary Policy: restrictive