Inflation, Industrial Production Show Slight Declines

The Consumer Price Index (CPI) for December came in at -0.4%, the greatest decline since 2008.  The Core CPI - which excludes the cost of food and energy - came in flat at 0.0%.  The rapid decline in the cost of oil and gas has clearly had a dramatic impact on prices.  What the Core CPI is telling us, though, is that inflation - now only 1.6% - is showing no signs of approaching the 2% level that the Fed is reportedly using as their bellwether.  The weakness in prices is not unexpected - the numbers were in-line with market surveys - but they are now fueling a very active debate around the timing of interest rate increases.

General consensus points towards a late 2nd quarter increase in interest rates.  The weak economic numbers throughout the first half of January, however, are increasing speculation that the interest rate hikes may be delayed well into the 3rd quarter, and even as late as a mid-4th quarter increase.  Nothing that I've seen thus far would lead me to believe that rate increases will come in the first half of the year.  FOMC has a two-day meeting the last week of January, and the weak data to date should have even the hawks on the committee taking a wait-and-see position.

On the production side, the numbers released this morning were somewhat mixed. Industrial Production decreased 0.1% in December.  That decrease follows a dramatic 1.3% increase in November. The bulk of the decline was in the Utilities sector, though, where heating demand dropped significantly.  When you take utilities out of the equation, industrial production experienced a 0.7% increase.  That's still a significant decline from the November numbers.

One encouraging note was a 1.4% rise in construction supplies.  This will warrant a closer look, since we may have a trading opportunity in that sector.  Defense and Space equipment rose 0.4% as did the production of materials with gains being seen in all major sectors.

The slope of Industrial Production over time is encouraging.  It's showing healthy year-over-year growth with no signs of the flat and downward slope that serves as a harbinger of a recession. (Look at the months preceding recessions in the charts below.) This adds fuel to the argument that current weakness in the overall economy is short-term and a reflection of the global picture, not the domestic picture.  What does concern me, however, is the strength of the US dollar.  While our production is strong, our ability to export is going to weaken unless we can tame the growth of the dollar.  That's another reason I don't believe a rate increase is imminent.  With the current strength of the dollar, a rate increase will add further pressure on our exports.  I just don't see the Fed ready to impose that pressure, and I don't see the key numbers - PPI, CPI, Retail Sales, and Consumer Confidence - moving in the direction the Fed needs before an increase is possible.

Industrial Capacity and Production