With Inflation And Treasury Rates Rising Again, The Fed Needs To ‘Think Big’
The biggest news last week was Tuesday’s August Consumer Price Index (CPI), which was expected to be negative. The consensus expectation was for a 0.1% decline, but the positive +0.1% monthly gain in the CPI shocked Wall Street. Even though energy prices declined 5% in August, led by a 10.6% decline in gasoline prices, food prices rose 0.8%. Excluding food and energy, the “core” CPI rose 0.6%, so inflation is now embedded in many service costs. In the past 12 months, the CPI rose 8.3% through August (down from an 8.5% annual pace in July), while the core CPI rose to a 6.3% annual pace, up from a 5.9% annual pace in June and July. Shocking everyone, the core CPI rose for the first time since March.
This inflation news spooked Treasury bond yields, pushing 10-year yields up from 3.36% on Monday to 3.42% on Tuesday. Due to the expectations that the August CPI could be negative, there were hopes that the Fed would not raise rates too much, but those hopes were dashed after most Treasury yields soared.
Frankly, since the Fed has to catch up with market rates, I strongly recommend that the Fed “think big” and hike key interest rates a full 1% tomorrow, September 21st. If the Fed only raises rates 0.75%, there will be pressure on the Fed to raise it again at the November and December Federal Open Market Committee (FOMC) meetings. Since the November FOMC meeting is only six days before the mid-term election, the Fed doesn’t want to raise rates then, but frankly, now that 2-year Treasury yields are at the highest level since 2007, the Fed must act, so a potential rate hike at the November FOMC meeting could be justified.
I want to make this very clear. If the Fed raises key interest rates at its November FOMC meeting, it will essentially signal a major leadership change in Congress. The best way to describe what is happening is that the Treasury market is now the “tail wagging the dog.” The stock market did not anticipate soaring Treasury yields, so some fiscal discipline from Washington, D.C., is now warranted, and hopefully, the new Congress will impose some fiscal discipline, because the European Union (EU) has learned that unlimited money printing (i.e., Modern Monetary Theory) has long-term consequences on Treasury yields.
With the anticipation now that the Fed may raise key interest rates to as high as 4% by year’s end, the U.S. dollar is resurging. Since a strong U.S. dollar impedes the earnings of the large multi-national stocks that dominate the S&P 500, reduced earnings in both the third and fourth quarters are likely to become bigger news. Fortunately for us, crude oil prices remain firm and other commodity-related stocks remain an oasis for investors, since they are forecasted to post positive earnings while the S&P 500 flounders.
The Labor Department reported better news Wednesday, announcing that the Producer Price Index (PPI) declined 0.1% in August, in line with economists’ consensus estimates. Wholesale energy prices declined 6%, while wholesale food prices were unchanged. The core PPI, which excludes food, energy and trade margins, rose 0.2%. In the past 12 months, the PPI and core PPI are up 8.7% and 5.6%, respectively.
One reason that energy prices have fallen is that the Biden Administration has been depleting the nation’s Strategic Petroleum Reserve (SPR) by one million barrels per day since March. According to the Energy Department, the SPR now stands at 434.1 million, its lowest level since 1984. Bloomberg reported on Tuesday that the Biden Administration is considering refilling the SPR when crude oil prices dip below $80 per barrel. This effectively puts a floor under crude oil prices, which is great news for energy stocks.
Complicating the energy supply conundrum, the Financial Times reported last week that the U.S. shale industry is telling Europe that they cannot bail them out this winter. Specifically, the U.S. shale industry cannot boost its production in time to help Europe this winter. Scott Sheffield, the chief executive of Pioneer Natural Resources, said, “We’re not adding (drilling) rigs and I don’t see anyone else adding rigs,” adding that crude oil prices could rise above $120 per barrel this winter as supplies tighten.
Another bullish news item for crude oil is that the Associated Press reported that 99 troops were killed in a border clash between Armenia and Azerbaijan. Since Azerbaijan is a major exporter of both crude oil and natural gas, this battle puts upward pressure on energy prices on fears that the conflict might expand.
In other inflation news, the Labor Department reported that the prices of imported goods declined 1% in August, following a 1.5% decline in July. The August decline in import prices was largely led by a 6.8% drop in fuel prices as crude oil prices declined 7.1%. Excluding fuel prices, non-fuel imports declined 0.2% in August. In the past 12 months, import prices have risen 7.8%, but that is the smallest increase since March 2021. Clearly, a strong U.S. dollar is key to putting downward pressure on import prices.
Other U.S. Economic News is Turning Up
The other big news last week was Thursday’s August retail sales report. Specifically, the Commerce Department announced that retail sales rose 0.3% in August, which is pretty good considering that gas station sales declined 4.2% due to falling fuel prices. Excluding gasoline, August retail sales rose 0.8%.
Vehicle sales rose by an impressive 3% in August, which is a good sign that consumers are buying big-ticket items. Other positive signs were a 1.1% rise in building materials and garden equipment, as well as a 1.1% increase in spending at bars and restaurants in August. However, July’s retail sales were revised down to a -0.4% decline, down from unchanged (zero gain) previously reported, so this downward revision may cause some economists to cut their third-quarter GDP estimates. Overall, based on the August data, consumers continue to spend freely, which is a good sign for continued GDP growth.
I should add that the Atlanta Fed on Thursday lowered its third-quarter GDP estimate to a 0.5% annual pace, down from its previous estimate of +1.3% annual growth. The consensus of private economists now ranges from -0.1% to 2.4% annual GDP growth for the third quarter – which at least implies no recession.
On the labor front, the Labor Department on Thursday announced that initial claims for unemployment in the latest week declined to 213,000, down from a revised 218,000 the previous week. Weekly claims have declined for five straight weeks, so the 4-week moving average of weekly claims continues to improve. Continuing unemployment claims rose to 1.473 million from a revised 1.437 million the previous week.
All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.
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