On Wednesday & Thursday, respectively, we got Producer Price Index (PPI) data and Consumer Price Index data. Inside these numbers, there really was not anything that screamed buy nor sell for either. In fact, both inflation data points show a resounding “higher for longer” scenario, and that is about all. But, what is the next move? Both of these data points show that there is not enough information within that says the Federal Reserve will hold, nor will the Fed need to raise. But, steady as we go is definitely in play.
So, how do we determine the next moves in inflation to see if the Federal Reserve will need to move higher or lower?
There are clues that drive the economy and if you start at the beginning, follow the circle around, it is possible to see where the pressure could be eased from inflation and then from there see that the Federal Reserve may have room to move downward.
Where does inflation begin?
First, understanding the basics of the economy and you look toward the potential future moves in inflation. In a normalized economy, in the United States, over 70% of the economy is driven by consumers as we are a service-based economy. This is the lion’s share of the economy, albeit not its entirety. Besides the consumer, there are government expenditures on goods & services, business expenditures, and net exports Main Aggregate Expenditures. There is also farm expenditures which are often lumped in but sometimes considered outside of these categories. Farm input and output represents a small portion of the overall economy.
But, current inflation is not driven by normal inputs and outputs. The supply chain collapsed with COVID shutdowns. Then, the world’s central bankers turned on the printing presses and bloated the world’s money supply. At the same time, said central bankers simultaneously dropped interest rates down to near zero – inducing a borrowing spree from consumers with housing and other expenditures that drove a broken supply chain to the brink. Finally, there is a war that shifted supply of oil which has driven price pressures. In other words, looking at the effects of what is going on with price pressures, you need to take in to account various outlying effects that are driving inflation pressures.
In summary, expenditures are a big part of what is driving inflation. But, the money supply, interest rates, and a somewhat recoiling supply chain are still affecting price pressures.
What is next for inflation?
First, where is inflation?
The above chart is both Headline CPI and Core CPI. The core prices take out food & energy which tend to be volatile. There are two things to note with this: consumers eat and drive vehicles while also heating houses. Consumers are feeling a big pinch crunch across the board when it comes to price pressures.
Within both of these inflation numbers is, of course, housing, and the cost thereof. Mortgage rates have pushed upward considerably since the nadir of the pandemic. And, any new homes or apartments are going to cost more relative to recent past because of the shift upward in mortgage rates.
Consumers & Inflation
As mentioned, one of the pillars of the economy is consumer consumption. Consumers consume. They do so at an increasing or decreasing rate of growth from one year to the next. This is done so with a correlation from the increase or decrease of the rate of growth of incomes to the rate of growth of expenditures:
As the rate of growth, on an annualized basis, of incomes increase or decrease, so too, does expenditures. This rate of growth is both from new entrants or individuals exiting income-generating jobs, as well as an overall increase in what any one individual is paid.
Expenditures drive inflation is the next piece of the puzzle. If you look at the charts above, the correlation between the rate of growth in incomes is very high when you consider the correlation between income and expenditures. Next is inflation. During a period where consumer incomes are increasing, as consumers deplete shelves of supplies, this pushes businesses to get into a different gear and produce more products (or, services). This pushes the demand cycle and likely pushes inflation at a relatively correlated pace. There is more of a breakdown in the rate of inflation and expenditures, but there is a correlation.
The next factor in the puzzle is the money supply. I have mentioned before that the money supply is a big factor in the inflation picture. It was both a solution to the COVID problem, and a part of the current inflation problem.
The Federal Reserve is actively shrinking the money supply in order to get back on to a trend-line growth level. But, for every action there is an equal and opposite reaction. The Federal Reserve is raising interest rates in order to contain economic growth and bring inflation back in to check. The other thing the Federal Reserve is doing is to shrink the money supply back down to trend-line growth rates. However, higher interest rates are attracting outside investors looking for higher yield, on a differential basis. This is actually expanding the money supply at the same time the that the Fed is trying to shrink the money supply.
TLT stock & TMF stock
My take on both TLT stock & TMF stock is simple: we are about where we need to be with interest rates as inflation remains elevated – interest rates will remain higher for longer. But, I do not believe that we are anywhere out of the woods just yet, and it has a lot to do with outlying factors such as the higher interest rates attracting differential interest rate seekers and wars.
I believe that interest rates are going to remain higher for longer. And, I believe inflation will likely remain elevated and not magically hit that 2.00% target level that the Federal Reserve is so desperately trying to seek. It will not be long before we see an uptick in core inflation, and that is when markets go red. Very red.
While I think we may have hit a bottom of sorts, with the potential of price pressures easing somewhat, I do not believe the Fed hit the exact interest rate level that would get price pressures to the target rate. For now, TLT stock & TMF stock may have hit a somewhat-bottom at these levels. But, eventually there will be a data point that not only suggest that the Fed needs to keep rates at higher levels for longer, but that the Fed needs to also raise interest rates more.
How much more? We are dependent upon multiple factors. We do not have enough information at this point. But, we are definitely not going to start moving upward for an extended period of time.