Highlights for this week include:
- While December’s CPI inflation reading came in higher than expected, we continue to see disinflationary forces that should lead toward the Federal Reserve’s (Fed’s) 2.0% inflation goal, providing the Fed with flexibility on future interest rate policy.
- December retail sales came in better than expected, showing that consumer demand remains strong which supports a positive outlook for the economy in early 2024.
- While early in the fourth quarter (4Q) earnings season, earnings are coming in better than expected, and we expect this to continue. Companies benefitted from better-than-expected economic growth and subsiding cost pressures throughout 2023, and this should continue to be reflected in 4Q results.
Inflation is Still Moving Towards the Federal Reserve’s 2.0% Target
The December Consumer Price Index (CPI) came in higher than expected at 0.3% m/m or 3.4% y/y, with core CPI (excludes volatile food and energy) edging down to 3.9% y/y, the lowest rate since May 2021. While Treasury bond yields moved higher in response, we continue to see inflation falling toward the Fed’s 2% target for several reasons.
Shelter is the main driver of high core inflation, falling to 6.2% in December from 6.5% y/y in November, and accounting for over 2/3 of core inflation (Core CPI ex Shelter is just 2.2% y/y). The Rent of Primary Residence and Owners’ Equivalent Rent components of CPI peaked in early 2023 and both follow asking rents with a lag. Asking rents peaked in early 2022 and are now in line with pre-pandemic levels, suggesting lower shelter CPI readings in the coming months.
In addition, the Producer Price Index (PPI) for final demand ticked up 1.0% y/y, still near the lowest level in three years—also suggesting the CPI will remain on a disinflationary path. The just released Industrial Production and Capacity Utilization report showed capacity utilization is running 1.1% below its long-run average which is also consistent with lower future inflation.
Consumer Remains Resilient
Consumer spending ended the year on a strong note, with retail sales rising 0.6% in December, the most in three months, and above the consensus estimate of 0.4%. On a y/y trend basis, retail sales were up 3.9%, the fastest pace in ten months. The acceleration confirms that despite headwinds from high interest rates, tighter bank lending standards, and the resumption of student loan payments a couple of months ago, consumer demand remains strong. This better-than-expected spending is raising estimates for fourth quarter economic growth, which is tracking at a 2.4% annualized rate according to the Atlanta Fed’s GDPNow Model. The current momentum also supports a positive outlook for economic growth in early 2024.
We Remain Constructive on Stocks
While early in the 4Q earnings season, earnings are coming in better than expected, and given better-than-expected 4Q economic growth, we expect this to continue. While the recent move higher in Treasury bond yields presents a headwind, receding inflation should support stabilization in bond yields. High yield bond yields, which often provide a warning signal for stocks and the economy, are consistent with further positive economic performance. We are also encouraged by cyclical sector leadership and lagging defensive sectors which typically outperform during tough or uncertain economic periods.
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