PCE flat, paves way for 50bps next week

and coal update

The mainstream press and several non-voting FOMC officials have been busy promoting a smaller hike at next week’s meeting. They have breathlessly claimed that inflation is rapidly re-approaching the 2% goal and that the Fed needs to slow down. Today, we have more data that shows that inflation is retreating from the highs.

The personal consumption expenditure (PCE) price index increased by 5.0% year-over-year in December. It was the third consecutive decrease in the price index. It came down 0.5% from the November rate of change of 5.5%. Breaking down the components, prices for goods were up 4.6%, services 5.2%. Food cost was the big one. It was up 11.2%. Energy was also up 6.9%. Compared to the previous month, the PCE was up 0.1% month-over-month.

This is the last piece of inflation data that the Fed will get to ponder before their meeting next week. The day their meeting opens, we’ll see employment data from ADP and JOLTs. I’m still holding to the idea that the Fed will raise by 50bps. I know that Tom Luongo also believes this but now

Mohamed El-Erian, the chief economic adviser at Allianz, wrote an op-ed at Bloomberg yesterday and in it, he calls on the Fed to raise the Fed Funds Rate by 50 basis points. He outlined four important points in why 50bps would be appropriate. While all four have their merits, one stuck out to me in particular.

“While inflation will indeed continue to come down in the immediate future, its main drivers have been shifting to the service sector, thereby increasing the risk of more embedded price pressures when the labor market remains solid.”

I think this is why Powell has been so fixated on the job market. A wage-price spiral is haunting Keynesian economists across the mainstream media. I’m not a believer in the idea. My belief is that inflation arises from an increase in the quantity of money. A wage-price spiral will break naturally if the quantity of money is not increased. We’ve seen average hourly earnings increase, though not as rapidly as the CPI, PPI, or PCE.

Which makes me think that this inflation hasn’t completely played out. There will be a round two. Its arrival will depend greatly on commodity costs as there has been a serious under-investment in development of essential commodities.

The old adage is that the cure for high prices is high prices. What this means is that when a specific sector of the market sees a big increase in price, it signals to entrepreneurs that there is a profit opportunity in that sector if they act fast. As more flock to the opportunity, prices come down as competition heats up.

In the past we see this during disasters. Prices for necessary items go up as supply dwindles. Government officials then come in and attempt to regulate the process calling entrepreneurs “price gougers”. This hampers the process of returning to normal and causes mis-allocation of resources in the marketplace. We are seeing the same thing on a much larger scale today…