All the major indexes finished with at least 0.8% gains on Thursday, despite a higher-than-expected August producer price index reading before the bell. The August PPI came in hotter than investors were hoping it would at 0.7%. It was, in fact, the largest monthly increase in final demand prices since rising 0.9% in June 2022. But here's the catch: The increase was primarily caused by surging energy prices. Core PPI was up just 0.2% on a month-over-month basis, in line with the consensus. This followed August's consumer price index reading that also came in above expectations.
From June 2022 to June 2023, the CPI was cut by two-thirds to just 3%. But it has ticked up in both of the last two months now. Noted economist Mohamed A. El-Erian had a good piece out on Bloomberg this week postulating that the "last mile" on the inflation front will take longer and be more challenging to get to the Federal Reserve's official 2% target than most think.
Not helping on the inflation front is that oil topped $90 a barrel this week for the first time since last November. Given the recent extended production cuts from Russia and Saudi Arabia, still solid economic growth here and a depleted Strategic Petroleum Reserve, crude is likely to remain elevated for some time. Meanwhile, the United Auto Workers union has just initiated limited strikes against the Big Three automakers simultaneously. Negotiations could last a while, but in the end, the union probably wins 25% to 30% wage hikes over four years. This follows 40% gains over four years by pilots at major airlines this summer, along with massive wage hikes recently for the employees at UPS (UPS) . All of this supports my rates will be "higher for longer" thesis as inflation will be quite stubborn to bring down from here.
Meanwhile, August retail sales (0.6%) came in significantly above expectations for the second straight month. Some caveats, however, should be taken into consideration. First, two-thirds of the increase was due to surging gas prices. Take that out, and August retail sales rose only 0.2%, the slowest rate since this March. I will also look forward to seeing personal savings levels for August, when that report comes out later this month. July's robust retail sales were supported by consumers drawing down their aggregate personal savings by nearly $150 billion to just over $700 billion.
Clearly this is unsustainable, especially since excess personal savings from Covid have been largely burnt through. It is hard to see the consumer (70% of economic activity) hold up in the quarters ahead. What cost $850 worth of earnings to purchase at the beginning of 2021 now costs $1,000. Now that their savings have been depleted, consumers have been turning to debt to support their spending levels. Both credit card debt ($1.03 trillion) and auto loan liabilities ($1.6 trillion) are at record highs and the average interest rate on both have surged in recent years. That's one reason delinquency rates on the former are on the move up and on the latter are starting to approach levels not seen since the aftermath of the Great Financial Crisis a decade and a half ago.
Unfortunately, I can see only two likely scenarios in the quarters ahead. A sustained bout of stagflation, given stubborn inflation headwinds and poor growth prospects. The other logical outcome is the Federal Reserve maintains high rates, until the economy is in recession. Neither scenario is supportive of the markets at current trading levels.
