The Bureau of Economic Analysis (BEA) released today the January CPI reports and the results are not looking good. CPI for January was 6.4%, which is a slight slow from the previous month when inflation was estimated at 6.5%. This slow though is timid and does not improve the overall general of prices.
In January, the percentage of all items was above 6.4%, food price at 10%, energy at 9%, and all items less food and energy at 5.2%. Indeed, the CPI for all items rose 0.5% in January as shelter increased. How will this new CPI report affect the economy and potentially financial markets?
Source: U.S. Bureau of Labor Statistics
The inflation rate remains way above its standard level of sustentation. As we know, an economy is considered to be growing healthily when the money supply matches the level of real output. The money supply currently outpaces the level of real output. The Federal Reserve has been applying soft landing as a means to tame inflation and avoid a recession at the same time.
Source: Bureau of Economic Analysis
The increase in interest rates throughout the year 2022 led to an increase in personal savings for consumers. As we can see, in a matter of five months, personal savings increased substantially from 2.4% in August 2022 to 3.4% in December 2022 while consumption expenditures decreased from 0.7% in August 2022 to -0.3% in December 2022. High inflation is no good news for businesses. With this new report released, consumers will continue to save as much as they can, which means that businesses will generate less income than they anticipate for this quarter. Thus, businesses will have to keep cutting costs in order to stay afloat. It is very likely that the Federal Reserve increase interest rates in March, which will maintain the cost of borrowing expensive.
Source: Board of Governors of the Federal reserve
The potential increase in interest rates in March 2023 will also affect financial markets, notably capital markets and asset markets. In capital markets, especially in the stock market, corporations will continue cutting growth to some extent and therefore dividends for shareholders. With lowered expectations in the growth and future cash flow of companies, investors may have to sell some of their shares to cut their losses since the stock price of the company they own won’t appreciate as anticipated. In the bond market, as interest rates rise, the cost of borrowing becomes more expensive for them, resulting in higher-yielding debt issuances. This means that the bond price goes down. That’s because new bonds will soon be coming onto the market offering investors higher interest rate payments. In the asset markets, especially in the real estate market, the raise of interest rates will make the price of mortgages higher for potential homebuyers. This in return will reduce the price of housing because as it becomes costly to borrow, more people will want to wait until the price of housing falls before they can pour themselves into that market.
So far nothing is definitive but there is a strong likelihood that the Federal Reserve might boost interest rates again. Everything will depend on the CPI report for February, and how low inflation will fall. If inflation falls all the way to the 5% range, the Feds may ease up on the interest rates. But if inflation remains within the 6% range, Jerome Powell will continue increasing those fund rates.