Pro Perspectives 2/21/23

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February 21, 2023
 
The Fed's favored gauge of inflation is core PCE (personal consumption expenditures).  It measures the change in prices of goods and services that people have actually paid — not just a selling price. "Core," means excluding food and energy prices. 
 
The January report on core PCE will come Friday.
 
As you can see in this chart, year-over-year Core PCE has been trending lower since last summer. 
That said, we already know from the CPI data last week, that price pressures were hot in January, compared to December.  We should expect a similar message from Friday's core PCE.  
 
So, the question: Is January a signal for what's coming (i.e. a strong bounce back in inflation)?  
 
Take a look at used car prices.  Used car prices topped out in January of last year, and bottomed in November.  Year-to-date this index is already up 7%.  
With the hot price data we've already seen from January, yields are on the move.  
 
The 10-year yield traded to 3.96% today.  That's up from 3.33% just earlier this month. 
 
This move in yields (higher) is triggering some fear in the stock market.  Stocks are down almost 4% in three trading days.  The VIX is up to the highest levels since the beginning of the year.  
 
Is this move in the bond market (yields higher), a signal to the stock market that the Fed might return to it's game of a year ago, where it put a strangle hold on the economy (and consumer confidence)?
 
If so, yields would be going the other way (lower). 
 
The bond market would be pricing in an even deeper and uglier recession, in the form of an even steeper inversion of the yield curve (an historic predictor of recession).
 
That's not happening.  The yield curve (2s/10s) is little changed from the beginning of the month. 
 
What is happening?  Contrary to the consensus view that recession is looming, we're seeing no signs that the economy is faltering (quite the opposite).  
 
The bounce back in economic activity in January has been strong.
 
Despite the Fed's best efforts, the job market remains tight.  And with the resilience of the job market, a sense of job security is good for confidence.  With that, confidence is coming back from record low levels of the early 80s.
 
And as we've discussed, the Fed has now taken the Fed Funds rate ABOVE the rate of inflation (it's favored gauge, core PCE).  That's historically where the Fed has gone to get inflation under control.
 
Meanwhile, they've normalized interest rates, and the economy is (still) on pace to put up another (consecutive) 2.5%+ growth quarter.    
 
Perhaps the bond market is beginning to price OUT recession (and a flattening of the yield curve).