Takeaways from January’s CPI Announcement

by Michael Olivia, William Combs of The Olivia Team, 2/24/23

January’s Consumer Price Index (CPI) released this week by the Bureau of Labor Statistics moderated to 6.4% on an annual basis, down from December’s 6.5% and well below its peak of 9.1% in June 2022. On a monthly basis, prices in January increased by 0.5% compared to 0.1% in December.

What markets fear most right now is a continued rise in inflation. In our view, markets are more concerned with a more aggressive monetary policy from the Fed than with the actual inflation numbers. Many economists feel that the Fed will push rates too far, send the economy into a tailspin, to which the Fed will promptly respond with interest rate cuts and perhaps additional monetary stimulus. Interesting to note that “too far” is another 25-50bps from where we are now – indicating just how dependent our economy is on cheap money.

What is yet to be seen in markets is a strong reflection of potential economic woes. So far, bad news for the economy has been interpreted as good news for the inflation fight, and as a result, good news for the market. That has been the case so long as the primary market concern has been inflation and the Fed’s reaction to inflation. Should that shift, and the health of the economy, corporate revenues and layoffs come into focus, we would expect more volatility in the market.

It is important to consider that the concerns of the January CPI are short-term in nature. We are more concerned with the long-term impact of inflation. This would mean a cycle similar to the 70’s and 80’s where inflation fights were paused to focus on unemployment, only to again focus on beating inflation. That cycle lasted a decade, and be assured that each time we paused the fight on inflation, it was because we believed inflation was at a level they felt was tenable compared with unemployment. Said differently, the economy would take precedent over inflation fights. It wasn’t until inflation and unemployment were both rising and over 10% before the monetary authorities would admit that inflation was the main culprit behind the struggling economy.

There is a view among current economists who feel that when employment decreases, so too then inflation decreases. If people aren’t making money (working), then the logic says that they cannot spend money, and therefore prices will drop. And while we don’t argue that there is a correlation between unemployment and inflation, we do not believe that there is a causal relationship. In other words, one’s employment status does not cause inflation.