My expert, analytical reaction to Friday’s inflation report: Ugh!

The U.S. Bureau of Economic Analysis (BEA) reported Friday that the headline personal consumption expenditures (PCE) price index climbed to 5.4% on a yearly basis in January from 5.3% in December. This reading exceeded consensus expectations of 4.9% and represented the fastest rate of increase since June.

After Friday’s unexpectedly hot PCE print, further significant monetary tightening by the Federal Reserve is in the cards, which in turn threatens the economy and the year-to-date equity rally.

The PCE is the Fed’s preferred inflation measure because it covers a much broader range of spending than the consumer price index (CPI), which only reflects out-of-pocket spending.

The following chart shows the long-term PCE trend, going back five years:

The annual “core” PCE price index in January ticked higher to 4.7% from 4.6% in December, compared to economists’ forecast of 4.3%. On a monthly basis, core and headline PCE inflation both rose 0.6%.

The Fed pays particularly close attention to the core PCE, because it conveys a better long-term indicator of where inflation is headed. The core reading strips out food and energy prices, which can be volatile over shorter time periods.

Overall, goods inflation is coming down nicely but services remains high. In the context of the inflation experience of the 1970s and early 1980s, it takes longer for services inflation (rents, wages, etc.) to come down.

Supply-chain bottlenecks have largely healed, but lately inflation has been driven by consumer demand. Last week, January readings for the CPI and producer price index (PPI) also came in higher than expected.

Read This Story: Inflation: Down But Not Out

This Friday, other economic indicators came in hot as well. The BEA reported that personal income increased by 0.6% on a monthly basis in January and personal spending increased by 1.8%.

With the unemployment rate at its lowest level since 1969, fierce competition for a tight supply of workers has kept upward pressure on wage growth.

In addition, consumer spending (adjusted for prices) jumped 1.1% from the previous month, the most in nearly two years, after consecutive declines. Household savings still hover at high levels.

The University of Michigan reported Friday that year-ahead inflation expectations rebounded to 4.1% in February, from 3.9% in January and 4.4% in December. Consumer sentiment this month rose 3% above January.

The odds of a 50-basis point (bps) hike in the target rate at the next Fed meeting in March, instead of the signaled 25 bps, just spiked.

In the wake of the disappointing economic news, the main U.S. stock market indices closed sharply lower Friday as follows:

• DJIA: -1.02%
• S&P 500: -1.05%
• NASDAQ: -1.69%
• Russell 2000: -0.92%

The benchmark 10-year Treasury yield rose past 3.94%, as investors increasingly give up hope for an economic soft landing. The four equity averages on Friday wrapped up their worst week of the year.

After a promising start to 2023, Wall Street has hit a brick wall of hot inflation data and cold earnings results. According to FactSet, the blended year-over-year earnings decline for the fourth quarter is -4.7%.

Since March 2022, the Fed has fought inflation by hiking its key interest rate eight times, which raises borrowing costs for consumers and businesses. The fear is that the Fed’s actions will tip the economy into recession.

The U.S. central bank’s policymaking targets inflation at around 2.0%, a level deemed neutral for the overall economy. We’re a long way from that level.

Wall Street has been desperate for the Fed to ease up on its interest rate tightening cycle. But waiting for the Fed pivot resembles “Waiting for Godot,” an absurdist play in which the protagonists spend all their time trying to meet Godot…who never shows up.

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It’s too soon to say whether the bull run of 2023 is over. The Wall Street consensus still calls for a gain of roughly 10% or more for the S&P 500 this year. However, sticky inflation translates into sticky volatility.

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John Persinos is the editorial director of Investing Daily.

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