No Hints of Gathering Inflation in January’s CPI
Visions of inflation have been dancing around investors heads for months now given the amount of present and future monetary and fiscal policy stimulus, not to mention the improving news on the virus and vaccine front. January CPI numbers, however, continue to reflect benign price pressures. The overall rate increased 0.3% for the month versus a downwardly revised 0.2% in December (from 0.4%). The increase in the overall rate was driven mostly by higher gas prices. The biggest surprise was the core rate (ex-food and energy), being unchanged versus 0.2% expected and matching the unchanged December print. The overall rate (YoY) was 1.4%, matching December but below the 1.5% consensus. The core rate (YoY) was also 1.4% (lowest since June 2020) versus 1.6% prior and 1.5% expected. As investors drive TIPS breakeven inflation rates to multi-year highs in anticipation of greater inflation, the actual numbers still reflect muted price pressures. Treasury prices reversed losses and are higher on the news but gains may be limited with a 10-year note auction looming later today. Finally, in this week’s podcast we talk with Laura Whitaker, Founder and Executive Director of ESP to discuss what bankers can learn from non-profit leaders. The iTunes link can be found here and the Spotify link here.
As we mentioned above, investors have been bidding up Treasury Inflation Protected Securities in the thought that with the Fed in full accommodation mode, and with the present and future fiscal stimulus, inflation has only one way to go and that is up. The graph below shows both the 5-Year and 10-Year TIPS Breakeven Rates and the move up to multi-year highs is unmistakable. Just to refresh, TIP securities provide a small coupon payment but the investor also receives compensation based on the CPI. So with the market price of TIPS one can derive expectations of an inflation rate that would put the investor on par with a nominal Treasury security. And this move in TIPS bonds has been one of the reasons nominal Treasuries have been on the back foot lately.
Also contributing to the upward move in inflation expectations is the Fed’s new policy framework where they have provided forward guidance that says they won’t tighten policy (either rates or tapering QE) until inflation has reached 2%, and trending above. For now, the market is taking the Fed at its word that they will allow inflation and the economy to run a little hot before removing the proverbial punch bowl from revelers. We’ve mentioned before that while the monetary and fiscal stimulus programs will provide a bump to price pressures they will be more temporary until we move closer to full employment. Larger and more abundant paychecks, and pent-up demand, will sow the necessary ingredients for a longer, more durable increase in inflation. But is it prudent to think we will get back to the labor market we had pre-pandemic when we had unemployment at 3.5% and 159 million people employed? We look at that issue in more detail in the next section.
Labor Market Starting to Show Signs of Long-Term Scarring
One of the oddities of last week’s jobs report was with just 49,000 new jobs, the unemployment rate still managed a four-tenths decline from 6.7% to 6.3%. A couple things are responsible for that with one being the headline jobs number comes from the Establishment Survey while the various employment rates come from the Household Survey. That survey reported a 606,000 drop in the ranks of the unemployed but they all didn’t find jobs. The Household Survey reported a 200,000 gain in jobs while the labor force fell by 406,000 to 160.2 million. A year ago the labor force (those working and those looking for work) stood at 164.5 million, so more than 4 million people have left the labor force in the past year. That is they are neither working nor looking for work; thus, they are not counted as unemployed. Who are these people leaving the labor force? Well, for one mothers have been particularly vulnerable as they are forced to care for children schooling from home for almost the last year. It’s thought, however, many will return to the workforce once schools reopen in numbers and vaccinations are widespread across the population.
Another group that has left the labor force in numbers are the 55 and over cohort. The above graph shows the labor force participation rate for that group dating back to the last recession. To put that into some context, since August, we’ve added back 2.7 million jobs for workers under 55. For those over 55 it’s just 28,000. It makes a certain amount of sense on one level that the older group that can accelerate retirement plans have done so rather than wait out an uncertain future. An age vulnerable group returning to work when the virus is still likely among us is a weighty decision for sure and one that many will say is not worth it. In addition, for those that lost jobs the prospect of returning to be retrained in a new field or skill is obviously not appealing. Thus, the decline in participation in this group is not likely to rebound significantly. With a permanently smaller labor force we may get to full employment faster than we thought, not because we’re adding jobs in droves but because the labor force is smaller. That change has wage implications too as employers start to confront the smaller labor force when trying to add new positions. New hires, and existing workers, may be in a position to demand higher wages as the labor market tightens faster than expected. That possibility could be driving some of the inflation expectations too and that development would lead to a more durable increase in price pressures.
Agency Indications — FNMA / FHLMC Callable Rates
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