This week’s consumer price index (CPI) report is likely to show inflation once again moving higher. This should raise expectations for interest rates to go higher or remain high for longer than current estimates. Although the economic numbers are mixed, expect the economy to weaken significantly in the months ahead.
The Week That Was
It was another week of confusing economic news.
August business surveys from ISM and S&P provided two dramatically different reports. Supply side managers (ISM) reported soaring business conditions, while S&P reported business conditionswere flat to down.
Similarly conflicting reports from the Fed of Atlanta and the Fed of St. Louis estimated third quarter real growth at 5.6 percent and 0 percent, respectively. These reports show is there is no consensus about where the economy is now, nor where it is heading.
Amid all this uncertainty, we continue to rely on monetary conditions to forecast upcoming
developments. Monetary conditions point to a weaker economy.
Things to Come
The main news for this week will be Wednesday’s August CPI report. We estimate oil and gasoline prices rose about 10 percent from early July to early August. As a result, the Fed of Cleveland estimates the total CPI rose 0.8 percent (a 10 percent annual rate). This would bring the yearly CPI rate up from 3.3 percent to 3.9 percent.
The Fed of Cleveland’s estimate of core inflation is more bad news. It calls for a 0.4 percent increase (a 5 percent annual rate). Although the yearly core inflation rate would slip from 4.7 percent to 4.5 percent, it leaves inflation well above the Fed’s target.
With oil prices continuing to soar into September, we can expect little near-term relief from higher inflation in next month’s CPI report.
Thursday’s report on August retail sales and Friday’s report on August manufacturing will round out next week’s news. Unlike the CPI report, none of these developments is likely to impact financial markets.
Market Forces
Stocks declined this week after increasing sharply in late August. The S&P500 fell 2 percent, the Nasdaq was down 1 percent, and small caps fell 3 percent to 4 percent.
These declines reversed most of the improvement in technical or psychological indicators. Technical indicators for the S&P500, Nasdaq, and Dow have held up reasonably well. However, the decline in small cap stocks has brought them close to ultimate support at their 200-day moving average.
The stock decline was widely attributed to very upbeat August ISM business surveys. Strong readings led some to conclude that interest rates would head higher for longer than anticipated. As noted below, other surveys contradict this strength.
A more likely reason for the decline in stocks is the upcoming CPI report. A surge in oil prices will lead to much higher inflation reports for both August and September. This should raise expectations that interest rates will move higher or stay high for a longer period. This would be bad news for stocks.
Expect the Fed to hold the fed funds rate stable at its meeting later this month, while continuing to sell securities. If so, sales of securities would continue through November. By then, the money supply would be down 21 percent from a year ago and unchanged compared to two years ago.
Although the economic numbers are mixed, expect the economy to weaken significantly in the months ahead. This weakness will put downward pressure on stocks.
Outlook
Economic Fundamentals: slightly negative
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive
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