Economic Report Summary: Core Inflation Rose, Broad Equity Markets Weakened

by: Tim Iacono

Following is a summary of last week's economic reports. A rising consumer price index highlighted the week, confirming the continued concern expressed by the Federal Reserve regarding inflation. For the week, the S&P 500 Index fell 0.3 percent to 1,451 and the yield of the 10-year U.S. Treasury note fell 2 basis points to 4.67 percent.

Consumer Prices: The consumer price index rose 0.2 percent in January after an increase of 0.4 percent in December and the core rate of inflation, excluding food and energy, surprised to the upside rising 0.3 percent after a 0.2 percent increase the previous month. On a year-over-year basis, the CPI rose 2.1 in January and the core rate gained 2.7 percent, reversing the recent trend of moderating core consumer prices (see the purple line in the chart below).

Rising costs for both medical expenses (up 0.8 percent) and food (up 0.7 percent) were the major factors contributing to the monthly increase. Energy costs declined (down 1.5 percent) led by fuel oil (down 4.4 percent) and gasoline (down 3.0 percent). Rising medical costs are troublesome in that the increase was concentrated in the medical care services category that rose sharply (up 0.9 percent). With energy prices set to reverse course with next months' report, the combination of these two could result in a much worse report for February.

With this release, the Bureau of Labor Statistics [BLS] provides three additional decimal places for the monthly data. Despite the headline figure, this month's core CPI change registers only 0.25565 percent - not nearly as ominous looking as the rounded-up figure of 0.3. The added precision should not be mistaken for added accuracy. The subject of defining "inflation" continues to be a controversial topic where the most popular inflation measure, the BLS's consumer price index, appears to continue to lose favor to a number of other measures available from other government agencies.

Nonetheless, this month's increase to the core CPI and the tick upward in the year-over-year rate are not good news for policy makers. Interest rate cuts are now likely out of the question until there is downward movement in core inflation or significant economic weakness develops.

Leading Economic Indicators:
The Conference Board's Leading Economic Indicators rose 0.1 percent in January, down from an upwardly revised gain of 0.6 percent in December. Six of the ten components declined, led by building permits and manufacturing hours. Consumer expectations and jobless claims led the list of components that gained, however, jobless claims have risen during the last two weeks, likely an indication of a reversal for this component next month.

MBA Purchase Applications: In a sharp break from the recent stability in the measure of new mortgage applications, a decline of 4.8 percent was seen last week putting the current level near the multi-year lows of last fall. Prior to last fall, current levels had not been seen since mid-2003, just before the housing boom kicked into high gear.

FOMC Meeting Minutes: The minutes of the Federal Reserve Open Market Committee meeting in January indicated that inflation is still the primary concern of the policy setting group and that the potential for housing weakness to spread to other parts of the economy was being watched closely.

All meeting participants expressed some concern about the outlook for inflation. To be sure, incoming data had suggested some improvement in core inflation, and a further gradual decline was seen as the most likely outcome, fostered in part by the continued stability of inflation expectations. However, participants did not yet see a downtrend in core inflation as definitively established.

All members agreed that the statement should continue to stress that some inflation risks remained and note that additional policy firming was possible.
The ongoing contraction in the housing sector and the potential for spillovers to other sectors remained notable downside risks to economic activity, although those risks had diminished somewhat, and continuing strength in consumption suggested upside risks as well. All members agreed that the predominant concern remained the risk that inflation would fail to moderate as desired.

By far, the worst case scenario for the Fed would be the combination of higher consumer prices and a faltering housing market affecting the broader economy. The most recent data indicates that this may be where the economy is headed.

Summary: The surprise move upward in core inflation provided confirmation that inflation has not yet been whipped into submission. Asset markets reacted accordingly. Broad equity markets weakened, apparently fearful of future interest rate hikes or the lessening probability of interest rate cuts. Hard assets rose as the eroding purchasing power of the dollar became more pronounced. This marks the second consecutive week of what would fairly be termed "mostly negative" economic reports following many weeks of generally positive data. If this trend continues, the mid-February time 'frame will be looked back upon as the period when economic indicators turned around.

The Week Ahead

The week ahead will contain two important reports on housing - existing home sale on Tuesday and new home sales on Wednesday. Also on tap are reports on durable goods and consumer confidence on Tuesday, the second of three readings for fourth quarter GDP on Wednesday, personal income and spending along with construction spending and the ISM Manufacturing index on Thursday, ending the week with consumer sentiment on Friday.

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