We’re about to get more clarity on the inflation picture…
The yield on 10-year U.S. Treasury bonds has been on a tear higher of late. Since dropping to as low as 3.6% in mid-September, the rate has surged all the way back to 4.7% during the past week. Now, that’s a monster move in a year’s time let alone three and a half months.
As you can see in the chart above, that’s the highest yield on U.S. sovereign bonds since April 2024. Wall Street’s concerned that inflation growth is picking back up. Those fears were stoked earlier this week when the Institute for Supply Management’s Services PMI gauge showed the prices index increased while the U.S. Bureau of Labor Statistics’ (“BLS”) Job Openings and Turnover Survey indicated available opportunities increased.
However, that summary judgement may prove fleeting. If you parse the statement from ISM, it appears companies pulled demand forward in anticipation of a port strike that has been settled, and potential tariff increases from the incoming administration of President-elect Donald Trump. And in terms of the job openings increase, the number of unemployed people also jumped, keeping the ratio of available opportunities to people out of work at a ratio of 1.1. Unless we see a sustainable trend, neither should drive inflation.
But there’s another gauge I follow that tracks the headline consumer price index (“CPI”) closely. And according to what I see, when the results are reported tomorrow, price growth should have held steady, if not eased in December. That will support the outlook for easing inflation growth and a steady rally in the S&P 500 Index.
But don’t take my word for it, let’s look at what the data’s telling us…
Each month, a number of regional Fed banks reach out to manufacturing and services companies in their districts. They ask those businesses about the level of activity they’re seeing. They want to gauge whether commerce has improved, worsened, or stayed the same.
I like to follow the results from the Dallas, Kansas City, New York, and Philadelphia Fed banks. Those four districts combine for about 25% of national gross domestic product. By looking at the results we can get a sense of what’s transpiring nationally. In addition, the data comes out just before the end of each month, so it’s like having an early look into what might unfold when entities like the BLS release market-moving data.
Today, we’re focusing on the prices received results. The reading measures what those companies’ customers are willing to pay for the goods or services they’re buying. So, it’s akin to CPI. I want to break it down by the individual parts and then consider them together. So, let’s start with the manufacturing survey results…
In the above chart, you’ll see the prices received gauge is a leading indicator of inflation. Back in April 2020, the measure hit the cycle low just ahead of CPI. Then in November 2021, the gauge peaked about seven months prior to national prices. Ever since, our manufacturing index has been headed lower.
As you’ll notice on the right side of our graph, prices received have been stabilizing. The trend began in July 2023 and has been holding steady. Yet, this past month we experienced a sharp drop. My indicator barely registered above zero after holding just below double digits for the last five months.
The services sector was a bit different, but not much…
Like the manufacturing data we previously looked at, we can see that service sector hiring tends to closely track with the broader national picture. Of late, it has been flat lining. And, after being cut almost in half during November, the index rose slightly in December.
However, I wanted to take it one step further. I combined both the services and manufacturing results to give us a more complete picture…
For this combined measure, I tried to give the two indexes a weighting similar to what each would receive from the BLS. I weighted services as 65% of the average and goods at 35%. Again, the combined index tracks very closely with headline inflation, leading it higher and lower.
According to my results, the combined prices received index dropped in December compared to November. In fact, it hit the weakest level we’ve seen since August 2020. That tells me we should see little change to monthly CPI growth in December.
If that proves to be the case, it will mean the six-month average rate of growth for headline CPI is 0.07%. If we annualize that out over 12 months, that gets us to a 0.8% rate of annual growth.
We care because that type of growth is far below current levels and well below the central bank’s 2% target. That’s a huge deal for the monetary policy outlook. Currently, Wall Street is only pricing in a single rate cut next year in June. If inflation growth starts to plummet, that outlook should change in a hurry. Because the gap between price growth and borrowing costs would expand rapidly. That would mean a larger cushion for rate cuts.
Remember, at the start of 2024, inflation growth ran hot. That means the annualized number could appear high for a few more months. But as we move forward in 2025, we’ll start to lose the highest inflation readings. In fact, if the current pace of growth holds, we could see annualized numbers drop below 2% as soon as March. But instead of being caught up in the here and now, look ahead to where the conversation is going. Because the outlook should point to stable economic growth, underpinning a steady rally in the S&P 500.
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