It’s too soon to declare victory over inflation. That’s according to Minnesota Fed President Neel Kashkari, who said as much last week while hinting that the Fed might indeed boost rates at its next opportunity. His comments were echoed by Fed Governor Michelle Bowman, who was even more specific when she told a group of bankers in Ohio that her fellow policymakers “will need to increase the federal funds rate further to bring inflation down to our 2% target in a timely way.”¹ 

Then on Thursday Fed Chairman Jerome Powell said that markets had fallen for a few inflation “head fakes” in recent months and that supply-side improvements had probably run their course, implying that “a greater share of progress will have to come from tight monetary policy restraining the growth of aggregate demand.”²  

When the message coming from different Fed speakers at various events across the country comes out sounding so specific and so coordinated, it probably is. That means the base case for rates at the December 13th FOMC meeting should probably be for an additional increase. But it isn’t: As of Monday morning, fed fund futures pricing suggests only a small probability of that happening.³ 

Judging from the equity market’s reaction through mid-week, Kashkari’s and Bowman’s comments went mostly unnoticed. That’s because their semi-explicit warnings about the future direction of rates didn’t do much of anything stop an early Santa Claus rally that started two weeks ago and has now taken the NASDAQ Composite index up more than 9.5% and the S&P Index up more than 7% since their pre-Halloween troughs. Even Powell’s more detailed message on Thursday failed to make much of a dent: After a brief dip lower in the wake of his comments, equity markets continued their march higher into the weekend. (Thursday’s relatively downbeat mood was also influenced by a weak U.S. Treasury auction, during which bid-to-cover ratios – a key measure of demand for new U.S. treasuries – were uncomfortably weak for bonds and bills at almost every maturity node.⁴) 

It’s probably premature for markets to completely dismiss the risk of more fed-sponsored rate hikes and instead focus on when the cutting will begin. Like always, it’s the gap between market expectations and eventual economic realities that determines the response, and this particular gap feels increasingly dangerous to me. 

But let’s shift our focus and instead talk about Powell’s other material comment  – the one where he took careful aim at the U.S. consumer (termed “aggregate demand” in his remarks) by acknowledging an end to COVID-era supply chain disruptions and placing the blame for a recent uptick in inflationary pressure squarely on demand. If the Fed now believes that the final mile of its inflation-control journey depends not on supply-side factors but instead on how effectively Fed policy can beat back consumer demand, how, exactly, is that supposed to work? 

One way is to make interest rates so high that it eventually causes consumers who might otherwise be inclined to buy expensive stuff on credit to sit out and wait for a better financing environment before taking the plunge. That exact dynamic has been at work for a long time in the housing market, where the highest mortgage rates in two decades have been dissuading would-be buyers for at least a year and a half. But now, you’re starting to see that same influence more noticeably at work in buying plans for other big-ticket items like cars and consumer durables – something researchers at the University of Michigan have spent a significant amount of time studying.  

In fact, according to Big Blue’s data, roughly 35% of consumers who rated buying conditions for cars as “poor” mentioned high rates and tight credit conditions as a reason – with a big inflection point coming just in the last month or so. Around 15% of would-be buyers of consumer durables (things like appliances, computers and fishing boats) said the same thing, joining a whopping 68%-plus of prospective homebuyers who have felt that way for a long time. Little surprise, then, that last week’s update of consumer sentiment showed a continued fade back toward the historic depths plumbed in the middle of last year, all while inflation expectations continued to ratchet higher.⁵ 

So that’s one side of the buying-on-time equation, but what about the other? If borrowers are increasingly unwilling to buy on credit in this higher-for-longer environment, are banks actively competing for business among those dwindling few who are still willing to pay up for the privilege? Not quite. How do we know? Last week’s other notable economic release was the so-called “SLOOS” – the Fed’s senior loan officer’s opinion survey, a tally of how willing banks are to extend loans. That data, released Monday, showed that banks are still reporting tighter lending standards and demanding more aggressive lending terms, even as loan demand continues to weaken across virtually all segments.⁶ 

There were hopeful signs inside the report that we could be approaching “peak tightness” when it comes to SLOOS-derived loan dynamics, but new in this quarter’s SLOOS data were signs that even revolving credit demand – which had previously been strikingly resilient to higher rates – was finally hooking lower.

Finally, one other development from last week is worth mentioning: the bankruptcy of office hoteling giant WeWork. It would be tempting to believe that the company’s demise was an isolated incident resulting from an unfortunate confluence of the rising cost of leverage and a COVID-inspired spike in working from home. There’s still something unsettling about a company that went public just over three years ago and reached a peak market cap of almost $50 billion going belly-up so suddenly. Let’s hope that this story doesn’t become increasingly familiar.

What to watch this week 

It would be easy to point to Tuesday’s consumer price index (CPI) data and Wednesday’s producer price index (PPI) reading as the most important data on tap this week, and with inflation increasingly coming back into focus, I won’t argue with that. But inflation numbers themselves haven’t proven themselves to be especially market-moving lately, primarily a result of widespread confidence that the Federal Reserve has things well-in-hand even if the numbers get bumpy from month-to-month.  

Anything that shakes that confidence will of course put point-in-time measures like CPI and PPI data back at center stage. As I’ve argued before, the bigger danger than an aberrant CPI or PPI print at this stage is that inflation expectations become unmoored – something that’s become particularly true given that consumers themselves have started telling pollsters they’re worried about prices all over again. If that mindset grows and eventually finds its way into business leaders’ thinking as well, then we’ll have even better evidence that the inflation tide might be turning again. For that reason, it might make sense to pay closer attention to Wednesday’s business inflation expectations index from Atlanta Fed than it does to fret over a few tenths of a percent one way or the other in the CPI or PPI data. 

Meanwhile, with the U.S. consumer increasingly in focus, markets could take their cues from any indication that consumer spending is finally weakening. While Wednesday’s retail sales data would ordinarily represent the most comprehensive read, this week we also get a host of retail earnings releases from companies like Home Depot (Tuesday), Target (Wednesday) and Walmart (Thursday). By their very nature, earnings releases are far more insightful than macro data from the government. Pay particular attention to the extent to which discount retailers like Walmart, TJ Maxx and Ross are taking business from mid-end marketers like Target and Macy’s. 

On the industrial side of things, we’ll get our first two regional Fed manufacturing reports – Empire State on Wednesday and the Philly Fed on Thursday. Add to that Thursday’s industrial production report and the always-interesting capacity utilization figure embedded within it, and by the end of the week we’ll have a pretty good idea if trends in the smokestack economy remain flatlined. 

Finally, if any type of housing market data beyond mortgage rates is capable of lifting the depressed housing market off the floor, it would be an improvement in for-sale inventories. I wouldn’t get your hopes up, but if and when inventory relief shows up on the horizon, two places to see it would be the National Association of Homebuilder’s builder sentiment survey and the Census Departments housing starts and permits release. We get both this week.  

Political events remain ever-present. We’re one week closer to the next potential government shutdown (without a congressionally-approved budget or a continuing resolution, federal government funding runs out on November 17th), and although I still believe markets have become somewhat hardened to this recurring prospect, there’s always a risk that a long, drawn-out shutdown could begin to erode growth or undermine confidence in the U.S. government’s willingness to pay its debts. 

[1] https://www.reuters.com/markets/rates-bonds/feds-bowman-says-she-expects-further-policy-tightening-will-be-needed-2023-11-07/

[2] https://www.federalreserve.gov/newsevents/speech/powell20231109a.htm

[3] cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

[4] https://www.jec.senate.gov/public/_cache/files/86b0d8ac-0c59-4dca-9ad5-01ceb87d588c/treasury-auction-table-110923.pdf

[5] http://www.sca.isr.umich.edu/

[6] https://www.federalreserve.gov/data/documents/sloos-202310-charts.pdf

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