Financial News for the Week of January 13th, 2023

This week ushered in a new House Speaker and a fresh reading on CPI in major financial news. The former came after fifteen rounds of votes and several concessions made by Speaker McCarthy. Of those, arguably the biggest was a commitment to pairing an increase in the debt ceiling with cuts in government spending. U.S Treasury Security Janet Yellen informed Congress that the debt limit could be reached as early as next week, and Treasury will start to employ extraordinary measures which are expected to last until June. With Democrats unwilling to tie debt ceiling negotiations to cuts in spending, we are headed for more fiscal brinkmanship over the coming months.

After last week’s payrolls report, investors were eager to see the December reading on U.S. CPI to better gauge the future path of the policy rate. Going into the week, most market participants expected a further downshift in the pace of rate hikes when the FOMC next meets in early-February. Inflation is (finally) moving in the right direction, solidifying market pricing for a 25-bps hike in financial news. Equities were up 2% on the week, while the U.S. 10Y fell by roughly 10-bps and currently sits at 3.45%

Headline inflation fell 0.1% m/m – a tick below expectations – with the pullback largely attributed to weaker gasoline prices (-9.4%). The core measure rose by 0.3% which brought the twelve-month change to “just” 5.7% – the slowest pace of growth in over a year. Even more encouraging was the steady downward trend in the three-month annualized change, which now sits at 3.1% (Chart 1).

Distortions from the pandemic continued to show further evidence of easing, with core goods prices (-0.3%) falling for the third consecutive month. Declines were primarily concentrated in transportation, while most other categories were higher on the month. That said, retail inventories have been piling up more recently, suggesting we are likely to see further price declines in things like apparel, furniture, and electronics in the months ahead. While encouraging, a softening in goods prices alone can only go so far in bringing down inflation. Core services will also need to slow, and herein lies the problem. Shelter continues to make outsized gains and is not expected to rollover until mid-year. Meanwhile, services (excluding shelter), whose price growth is more closely tied to wages, is unlikely to slow until we see some softening in underlying labor market conditions. And that doesn’t appear to be on the immediate horizon.

Data out this week showed that while the number of small businesses reporting job openings are declining, they remain historically elevated (Chart 2). As a result, nearly half of small businesses surveyed reported having increased compensation in recent months, while more than a quarter are planning to boost wages over the next three months. Elsewhere, jobless claims continued to edge lower through the first week of January – falling to 205k – with the four-week moving average having steadily declined since late-November. Putting all this together suggests the labor market remains incredibly tight and has not yet reached an inflection point. So while inflation may be easing, the Fed is nowhere near declaring victory. We expect more tightening to come over the coming months – likely in the form of two 25-bps hikes – before pausing to assess the cumulative impact of all 475-bps of tightening.

Thomas Feltmate, Director  | 416-944-5730