FIDU - Why The Fed Follows The PCE Not The CPI Or PPI

2024-01-18 07:13:00 ET

Summary

• The core PCE in the past six months is running at a slower 1.9% annual pace, so the Fed’s 2% inflation target is within sight.
• Deflation is unquestionably enveloping the Chinese economy, and this deflation is being exported around the world, including the US.
• In addition, the manufacturing recession in the U.S. is contributing to deflation in goods prices here. The ISM non-manufacturing (service) index is also nearing 50, the mark of contraction.
• Also impacting GDP growth is the trade deficit. The Commerce Department has announced that the U.S. trade deficit declined 2% in November to $63.2 billion.

The Consumer Price Index (CPI) is often too hot (too inflationary), as consumers sometimes bid up prices and the Labor Department usually measures posted market prices, not necessarily the prices consumers pay (as they often seek items on sale). Meanwhile, the Producer Price Index is an index of primary goods, many of them imported from China and elsewhere, so it is sometimes deflationary, or "too cold."

Like the Goldilocks story, one measure of inflation is "just right," and that is the monthly PCE Index.

The next Personal Consumption Expenditure (PCE) index will be released towards the end of January. It is also called the “GDP deflator,” since it is the price index that reduces nominal prices to “real” (after inflation) prices. The PCE index declined -0.1% in November, which marked the first monthly decline in the PCE since Apri1 of 2020. In the past 12 months, to November, the PCE decelerated to a 2.6% pace, down from a revised 2.9% annual pace in October, so it is tamer than the CPI and brisker than the PPI.

In both October and November, the core PCE, excluding food and energy, rose only 0.1%. The core PCE in the past 12 months rose at a 3.2% annual pace through November. However, the core PCE in the past six months is running at a slower 1.9% annual pace, so the Fed’s 2% inflation target is within sight .

As I have said here for months, China is exporting its deflation to us, as reflected in our PPI. Deflation is unquestionably enveloping the Chinese economy, and this deflation is being exported around the world, not just to us. This explains why wholesale goods prices declined -0.6% in the December PPI report.

China’s wholesale prices declined -2.7% in 2023 and its exports declined -4.6%. China also reported that its consumer prices declined -0.3% in December, the third straight monthly decline. I should add that China’s exports rose 2.3% in December, while its imports rose 0.2%, so if demand for Chinese goods continue to rise, some of these deflationary forces may start to ebb in the upcoming months.

The manufacturing recession in the U.S. is also contributing to deflation in our goods prices here. The Institute of Supply Management (ISM) non-manufacturing (service) index is also nearing 50, the mark of contraction. Specifically, ISM announced that its service index plunged to 50.3 in December, down from 52.7 in November. This was a big shock, since economists were expecting a reading of 52.6. This fact has many economists now slashing their fourth-quarter GDP estimates and trimming 2024 estimates as well.

Also impacting GDP growth is the trade deficit. The Commerce Department on Tuesday announced that the U.S. trade deficit declined 2% in November to $63.2 billion. Exports and imports both declined by 1.9% in November to $253.7 billion and $316.7 billion, respectively. In the upcoming months, continued high energy exports are expected to shrink the U.S. trade deficit. A high trade deficit lowers U.S. GDP.

Treasury Secretary Janet Yellen has (perhaps prematurely) declared that a “soft landing” has occurred, and many economists agree with her. However, I’d say that more inflation data has to come in before the Fed finally relents and begins cutting key interest rates. Globally, evidence of deflation continues to spread. Besides China and Germany, the latest example is Chile, which announced that consumer prices declined -0.5% in December, a much bigger drop than economists’ consensus estimate of a -0.1% decline. This was the biggest monthly drop since 2013, so the Chilean central bank is expected to cut rates. The next question is: Will these deflationary forces spread to America? The answer is, I certainly expect so.

An Especially Cold Winter Should Boost Demand for Natural Gas

There was a weekend blizzard across much of America, including voters in the Iowa caucus on Monday, but 15,000 showed up to see the Iowa women’s college basketball game, so it’s just a matter of priorities!

The Arctic blast that has enveloped much of the U.S. may curtail gasoline demand, since traveling on icy roads can be treacherous, but the same Arctic blast that turned much of the U.S. into a popsicle also hit Europe, where Scandinavia is experiencing its coldest weather in 25 years. In Oslo, Norway, temperatures plunged to -20 degrees Centigrade (-4 Fahrenheit), which disrupted train schedules and caused havoc with the city’s electric bus fleet, since batteries do not like cold weather. The electric bus operator, VG, said “The range decreases, and it takes longer to charge the buses” in cold weather. Cold weather also caused Norway to curtail its natural gas production. After widespread flooding in Britain, France and other European countries, extra-cold temperatures below freezing have enveloped Berlin and Paris. Obviously, the U.S. will be exporting a lot of natural gas to Europe, which is good news for Dorian ( LPG ) .

The Energy Information Administration ((EIA)) reported a 5.5-million barrel decline in supplies in the latest week. This follows three previous weekly declines of 5.5 million, 6.9 million, and 7.1 million barrels (25 million total barrels in four weeks). The EIA also reported that U.S. crude oil production was 13.2 million barrels per day in the latest week, down from 13.3 million per day in the previous week.

I am planning on holding most of our crude oil producers through February, since seasonal demand is expected to pick up as spring approaches. The war situations around the world support energy stocks.

The truth of the matter is the Middle East is a tinder box and extremely unpredictable. In the meantime, commerce in the Red Sea has effectively ceased, since insurance companies do not want to insure ships. Do not be surprised if crude oil prices return to $80 per barrel during the next flare-up in the Middle East.

Other than multiple drone attacks continuing in the Red Sea, the latest incident was an oil tanker being hijacked. Last Thursday, the St. Nikolas was seized by armed men off the coast of Oman and is now headed to Iranian waters. The St. Nikolas had been previously commandeered by the U.S. for sanctions evasion. Obviously, this is a diplomatic incident and appears to be challenging international sanctions, so crude oil prices rose in the wake of the St. Nikolas being seized and diverted to Iranian waters.

Early last Friday, Britain’s Royal Navy and the U.S. Navy launched a coordinated attack of approximately 70 airstrikes on Houthi rebels in Yemen. Then, a radar facility in Yemen was attacked on Saturday. This is unquestionably a response to multiple drone attacks from Houthi rebels. Clearly, this is a major military escalation, so it will be interesting to see if there will be any further escalation in the Middle East. In the meantime, crude oil prices rose due to fears of possibly more disruptions in the upcoming weeks.

Speaking of disruptions, Tesla ( TSLA ) closed its Berlin manufacturing plant for two weeks due to parts shortages from the Red Sea shipping disruptions. Back in the U.S., the Tesla Cybertruck is testing Elon Musk’s basic theory that consumers will want an edgy design with a radically sloped front window. At the Consumer Electronics Show (CES) in Las Vegas, Honda ( HMC ) showed two EV concepts with radically sloped front windows, resembling the Lamborghini sport cars. The first of these new Honda EVs is expected to be announced in 2026. The other EV is a much larger van-shaped EV with no window in its rear, thanks to cameras. I suspect that these Hondas will be very successful, since consumers crave innovative design.

Despite various pledges to phase out fossil fuels, green energy alternatives are not cost-competitive. India has announced that it will be doubling its coal production by 2030 “to meet growing demand.” Sandeep Pai, director of Swaniti Global, said “India’s policy is to build everything. Push for renewables, but also push for coal and other fossil fuels.” He added that, “The justification is an increase in power demand.”

The Rhodium Group reported that U.S. greenhouse gas emissions declined 1.9% in 2023 due to an 8% reduction in power generation and 4% in the building sector. Emissions from the transportation sector rose 1.6%, due largely to higher airline travel. Coal generated 17% of electricity in the U.S. last year, a record low, but no matter what the U.S. and Europe does to curtail emissions, Brazil, China, Indonesia, India and other emerging market economies will continue to boost emissions, primarily from coal plants.

Navellier & Associates owns Dorian ((LPG)) in managed accounts. A few accounts own Tesla ((TSLA)) per client request. We do not own Honda Motor Co. ((HMC)). Louis Navellier and his family own Dorian ((LPG)) personally via a Navellier managed account, they do not own Tesla ((TSLA)), or Honda Motor Co. ((HMC)) personally.

All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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