Pro Perspectives 12/11/23





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December 11, 2023

We get the November inflation report tomorrow, and the Fed meeting on Wednesday.
Before we talk about what to expect for tomorrow, let's revisit the October inflation report.
Leading up to that big event, we talked about the trend of falling inflation, the continuation of which would put pressure on the Fed to cut rates aggressively next year, or subject the economy to the consequences of higher and higher (more and more restrictive) real interest rates (i.e. the difference between the Fed Funds Rate and the inflation rates). 
Of course, rising real rates would create even tighter financial conditions.  And with that, by overtightening the Fed could find itself following the mistake of 2021 (pouring fuel on the inflationary fire) with the opposite mistake in 2024 (inducing recession, if not a deflationary bust).
So, continuing with our revisit of last month's economic event, October inflation did indeed show the trend of falling inflation was intact.  The core inflation rate (excluding food and energy) broke 4% (at 3.96% on the index) for the first time since May of 2021, and markets immediately declared the rate hiking cycle as over
Stocks exploded higher.  Yields fell sharply.  And the dollar had one of its biggest declines of the past three years. 
These key markets have continued in those respective directions since that October inflation report.  And following that report, the interest rate market is now pricing in more rate cuts and sooner, to arrive at something closer to 4% by the end of next year (from current 5.33% effective fed funds rate).
So, what should we expect tomorrow, from the November inflation report? 
More of the same.
The consensus view is for little change from the last report (core at 4%, and the headline a touch lower at 3.1%).  But if we do have a surprise, it should be skewed toward weaker inflation. 
Why?  If we look at November prices globally, we've already seen deflation in the month-over-month price data out of both the euro zone and China.  Add to that, the biggest contributor to the sharp fall in U.S. inflation from 9% to 3% has been energy prices.  On that note, if we look at the price records from the EIA for November (Energy Information Administration), oil was down 8%, retail gas prices were down 9%, and natural gas was down 50% (all for the same period a year ago).  
So, the energy component will continue to weigh on the November consumer price index (CPI).  Although the Fed cares most about the core inflation rate (excluding food and energy prices), expect the media to celebrate the headline number tomorrow, particularly if we get a surprise breach below the 3% level.