I think inflation could be one of the most important factors driving the market narrative in 2020. The Fed would tell you that inflation is well under control and, in fact, it needs to take steps in order to INCREASE inflation.
By its preferred measure, the PCE index, that's still true, but more broadly accepted inflation measures tell a different story.
Both the inflation rate and the core inflation rate, which excludes food and energy prices, are above the Fed's 2% target and have been climbing for several months.
Producer prices, on the other hand, have yet to show any significant pricing pressure, which probably reinforces the Fed's notion that prices are contained and a neutral/dovish stance can be maintained.
While the Fed's dual mandate is to moderate both unemployment and inflation, its recent activities suggest anything but. It appears to have completed its "mid-cycle adjustment" with respect to the Fed Funds rate and is prepared to keep things steady for the foreseeable future. On the other hand, however, it's also been throwing hundreds of billions of dollars in liquidity at the economy.
Econ 101 would tell you that as more money is available to consumers and businesses, the proclivity to increase spending grows. As spending grows and there's more demand for a finite amount of goods and services, prices tend to rise (note: Jeff Miller in his weekly column does a great job of highlighting current inflation concerns).
As Jeff also notes, no inflation measure is perfect. Certain aspects are included and excluded, while there are differing opinions as to the degree of importance of certain factors. What these measures point out to me in aggregate is that prices appear to be rising and current Fed policy could drive them higher.
Nothing unusual is expected out of December's report (forecasts are for a rise of 0.2% month-over-month), but a reading of 0.3% should raise some eyebrows (although I'm not sure it will).
This position on inflation is why I'm bearish on Treasuries in 2020. Inflation should, in theory, lift the long end of the yield curve. With the Fed doing its job of suppressing short-term rates, the yield curve steepens. Treasuries and other fixed income products decline, especially high yield, while financials and TIPS likely stand to outperform.
That's why I'm watching this report closer than anything right now. CPI numbers come on Tuesday, while PPI is on Wednesday.
While these reports likely won't cause much of a ripple in the markets, they could set the stage for where rates are headed in the next 12 months.
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