August 17, 2023

Not good…

We’ve spoken here before about how critical it is for the Fed to maintain a sense of “street cred” in the eyes of the public. Specifically about how important it is for them to have the public believe that they can keep inflation at a 2% rate. (I don’t necessarily buy their argument why 2% annual inflation is a good thing but that’s a conversation for another time.) 

It’s imperative that they make everyone believe this because 1) if they can’t control inflation what good are they, but more importantly 2) if the country expects higher inflation/costs, they’ll behave accordingly. Higher wages will be demanded, prices will rise… 

Last week a number of inflation-related reports came out. And they weren’t all that encouraging.

Prices and the Prices of Prices

On Thursday, consumer prices were released. And they proved as sticky as ever. 

The year over year headline number showed a rise of 3.2% (vs 3% previously) and the core number (minus food and energy) was essentially unchanged at 4.7%

On Friday producer prices (the prices that go into consumer prices) came out. Producer prices have been pretty flat since November of 2022. This month they rose .8% over 12 months up from .2%. The core number, however, remained sharply higher, rising 2.4%.

We’ve explained in detail the relationship between producer and consumer prices. How the former drives the latter. We used Germany as an example. In an April weekly update of Streetlight Confidential we noted that Germany’s inflation rate was posted at 4.9% while its wholesale prices — the prices charged at the supplier level — rose 16.2% and producer prices — prices paid by manufacturers for raw materials — spiked a staggering 25%.

Two months after those reports had been posted…

In February, German producer prices made a new record high for the third straight month at 25.9%… Wholesale prices reached another record peak of 22.6% in March and… Inflation has exploded from 5.1% to 7.3%.

The point I want to make is that producer prices impact consumer prices. And the sticky prices we’ve been seeing are bound to keep the Fed on their guard. 

Believing the Pitch

The other report had to do with consumers’ beliefs… i.e. the Fed’s cred.

On Friday, the University of Michigan released its consumer sentiment index. The overall index edged lower to 71.2 from 71.6 suggesting the optimism that had been reported for the last couple months had cooled somewhat.

The inflation expectation report is likely to cause even more hand wringing at the Fed. The one year expectation came in at 3.3% while the five year expectation printed 2.9%.

Now, given that a year ago prices were raging 8%-9% higher a year, these numbers might seem outstanding. And they are much better.

But the Fed has a goal. A 2% goal. And 3% does not meet that goal.

The New York Fed maintains a similar survey and their June inflation expectations showed 3.8% one year out and 3% both three and five years out. 

It would seem like the Fed is starting to lose the battle for public confidence. 

And that’s one they can’t afford to lose…

Humbly yours, 

Tim Collins
Editor, Streetlight Daily