Services inflation will push interest rates higher than anticipated

Lots of commentators told us last year and even early this year, that inflation is dead. It reminds me of an old joke. Nietzsche used to say God is dead. The responses, God said, well, Nietzsche is dead. The fact is, inflation is not dead. It’s coming down. But it’s coming down gradually. We recently got the report on the consumer price index. And if you just look at the numbers, it’s hard to detect a trend, here they are for the last seven months 0.4 0.6 0.8 0.5 0.5 0.6 0.5. If you can look at those numbers and come up with anything other than a trendless 0.5, which, by the way, is a little over 6% inflation at an annual rate, well, then good luck to you, you’ve got better eyesight than I do, you really have to squint. So there’s no trend. By the way, these are the service numbers, the core service numbers, and that’s what the Fed is looking at the most. Because services, unlike goods tend not to be so volatile. We know for example, that energy services were extremely volatile. And that caused a lot of the movement in the headline CPI. But although energy prices went up 29% In the first half of the year, they came down 26% in the second half of the year, and now it looks like they’re on the way up. So that’s why the Federal Reserve and I prefer to look at the services number. The other thing that happened was we had some transitory deflation in prices that had simply gone too high. One great example is used cars, cars were in short supply, it was so bad that used cars came to cost almost as much as new cars. Well, it now looks like used car prices are going to come down, who’s going to go up again. They the wholesale index comprised of cars that large used car dealers buy, and it’s published a series called The Mannheim series, have now turned around and are rising. Well, the other interesting things in the report, the one that caught my eye, was what’s happening to food. And the CPI looks at two different food numbers, food purchased at home, which fell from a 16% inflation rate at the first half of the year, to quote nearly a 7% inflation in the last half of the year. Now that’s food consumed at home. But food if you go out to a restaurant actually rose in inflation from 8% in the first half of the year to 8.4% of the second half. Well, if eating out costs more, but food inflation is going down. What’s the difference? The difference is services. And that means that labor costs for those in the restaurant industry and elsewhere, are still rising, and in fact, they’re accelerating. We also had the Producer Price Index come out. The headline number was seven tenths of percent, which was the highest since June. And the core lever level which excludes food and energy was point 6%, the highest since March. The long term trends are coming down. Our forecast for 2023 is 3.9% inflation. It’s down somewhat, but it’s nowhere near what the Fed wants, which is 2% inflation. So whether we like it or not the FOMC the Federal Reserve is going to have to keep tightening monetary policy. That means higher rates than we now expect. And it also means that they’re going to have to continue with their quantitative tightening.