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Inflation Data Unwinds Some of the Post-Election Rally Stocks soared on 11/6/24 on investor optimism that the incoming Trump administration would issue business-friendly policies including relaxed regulations and additional tax cuts. The rally has since partly reversed, however, on still warm inflation data that underscores the difficulty in getting to the Fed's 2% inflation. Investors are also assessing the risk that new higher tariffs, cuts on income taxes on overtime and Social Security, and deportation of low-wage workers might reverse inflation progress to date. The clear Trump victory and House and Senate sweep mean that the president will have legislative support to enact his agenda. The CPI and PPI reports suggest that inflation could remain an ongoing challenge for the new administration. October CPI and PPI On 11/13/24, the Bureau of Labor Statistic within the Labor Department reported that the all-items consumer price index (CPI) for October increased 0.2% on a month-over-month basis. That increase was in line with both the September increase and with the consensus forecast for October. While 0.2% was expected, investors are frustrated that the monthly change has not ticked down to 0.1% or even 0.0%. Investor concerns centered on the annual change of 2.6% in consumer prices. The annual change matched the 2.6% consensus call but represented an increase from the 2.4% annual change reported for September 2024. Excluding food and energy, 'core' CPI rose 0.3% month over month and 3.3% year over year. Both the monthly change and the annual change in core CPI were in line with consensus expectations and level with prior-month readings. Producer prices capture data from further up the production chain and may indicate what consumers will face in coming months. While the CPI readings showed inflation stalled in place, the producer price index (PPI) indicated some backsliding on prices. For October, the all-items PPI rose 0.2%. Although that was in line with consensus, it was worse than the revised September PPI change of 0.1% (originally reported as 0.0%). On a year-over-year basis, the October all-items PPI rose 2.2%. That was a tick better than the 2.3% consensus forecast but was up from a revised 1.9% annual change for September (originally reported as 1.8%). There are two variants on core PPI: excluding food and energy, and excluding food, energy, and trade services. Ex food and energy, core PPI for October was up 0.3% month over month and 2.3% year over year. These changes represented higher monthly and annual inflation than was reported in September while matching pre-reporting consensus expectations. PPI excluding food, energy and trade services was up 0.3% monthly and 3.5% annually; both were worse than the 0.2% monthly change and the 3.2% annual change reported for September. Investor Takeaways Investors had two key takeaways from the CPI and PPI data, both all-items and core. The first was a reminder that getting through the 'last mile' of inflation to the Fed's 2% target remains challenging. Consumer inflation peaked at 9.1% in June 2022. The decline from that peak was initially rapid, but progress on inflation has been difficult to measure in the recent months and even the past year. The annual change in the October 2023 CPI was 3.4%, meaning it has taken a year to whittle inflation down by about one percentage point. The most stubborn components in October CPI remain related to services. According to the BLS, the index for shelter (meaning rents and rent equivalents) within the CPI rose 0.4% month over month and accounted for more than half of the monthly all-items increase. Shelter not only remains stubbornly elevated; it accounts for nearly one-third of the total consumer price index. Other CPI components have a smaller weighting but showed a worse trend. Used car and light truck prices unexpectedly shot higher by 2.7% from September, after posting negative changes over the June-August period. Another non-goods component, electricity services, rose 1.2% for October; this category too was subdued in the summer months. The second key takeaway is that neither the PPI nor the CPI is likely to prevent the Fed from enacting a 25-bps rate cut at its December meeting. But investor conviction that the Fed will end the year with a quarter-point cut is by no means as strong as it was a month ago. The Fed cut rates by 50 basis points (bps) at its September meeting and by 25 basis points at its October meeting. The October cut brought the central tendency in the fed funds rate to 4.5%-4.75%. The Federal Open Market Committee (FOMC) is scheduled to conduct its final meeting of the year on December 17 and 18. According to the CME Fed Watch tool as of 11/18/24, the probability of a 25-bps cut at that meeting is 58%. The probability of the Fed leaving rates unchanged is 42%. No other outcome - a shock rate hike, or a 50-bps cut - earned even a percentage point of probability. A month ago, the probability of a 25-bps cut at that meeting was 77%; and the probability of no cut was 22%. The Industrial Economy: Sentiment vs. Reality Recent data from the industrial economy supports the view that manufacturers would benefit from a lower rate environment. Industrial production for October slipped by 0.3%, after declining by the same amount in September. Industrial production aggregates manufacturing, mining and utility output. This indicator has softened in 2024 mainly due to weakness in mining, reflecting depressed demand from the world's biggest commodity consumer (China), and mixed trends in utility output due to mild weather. In October, both utility (up 0.7%) and mining output (up 0.3%) ticked higher, but manufacturing output declined by 0.5%. The Federal Reserve board, which reports this data, pointed out that industrial production in October was suppressed by a strike at a major aircraft producer (Boeing) and by the aftermath of Hurricanes Milton and Helene. The Industrial Production index was 0.3 percentage point below its year-earlier level. Capacity Utilization of 77.1% for October was 2.6 percentage points below its long-run average. Factory orders for September were also impacted by the Boeing strike, declining 0.5%. Whereas actual activity in the industrial sector has been tepid, the election appears to have unleashed business optimism. The Empire State Manufacturing index was the first sentiment index to at least partially capture post-election sentiment. The index shot higher to 33.2 for November, from negative 11.9 for October; the consensus forecast for this series was 0.0%. The National Federation of Independent Businesses (NFIB) reports its small business optimism index in the second week of December. This index, most recently at a depressed 93.7, is also expected to shoot higher on positive sentiment toward the change in administration. Conclusion The S&P 500 closed above 6.000 for the first time on 11/11/24. The index has since walked back to the around 5,900 as investors assess what the incoming administration means for the economy, interest rates and inflation. Changes in policies under a new administration risk rekindling inflation, but it is far too early to say what the actual impacts will be. Improving business sentiment could coincide with an improvement in actual economic activity amid recovery from the strike and storms impacts of recent months. Argus forecasts healthy spending in the holiday season, reflecting a fully employed workforce and slightly rising wages. While the stock market may not end the year at its highs, there is little reason to believe that recent moderation off the highs will lead to deeper selling.

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