Core CPI beat expectations as it was up 1.8% year over year. The estimates were for 1.7% growth which was what last month showed. This was the strongest gain in 11 months. The month over month increase was 0.3% which beat estimates for 0.2% growth. The headline CPI which includes food and energy was up 2.1% which met estimates and was down 0.1% from last month. The month over month inflation was only 0.1% which met estimates and was 0.3% below the prior report. Overall the headline number was in line and core inflation was above estimates.

Before we look at the details of the report, let’s review its effect on the markets. The dollar index sold off 0.65% to $91.30. The past few days for the dollar index have been important technically because the index is now at the lowest point since December 2014. The next support is in the low $80s. That’s bearish for the dollar, but bullish for international equities. I’ve discussed the possibility of the weak dollar’s effect on earnings waning if the dollar stabilized higher from here. With the recent decline, the weak dollar will be a tailwind for earnings throughout the year. Strong global growth, tax cuts, and a weak dollar are a triple threat for earnings to outperform in 2018.

The 10 year bond immediately sold off heavily after the release before regaining a bit a few hours later. The yield is 2.5627% which is an increase of 2.6 basis points. As you can see from the chart below, the 10 year yield is near the peak of 2017. Bond yields are now above dividend yields, showing how TINA investing is losing its muster. The selloff in bonds is good news as it means growth is accelerating. The 2 year bond hit above 2% for the first time since 2008. It’s at 2.0058% as it was up 2.72 basis points. That means the yield curve is at 55.69 basis points.

The chart below gives a bunch of different timelines for inflation. The year over year core inflation is still below 2016 levels, but the one month annualized change is at one of the highest points in the past 2+ years. This is the beginning of the increase in inflation in my eyes. The only reason why it’s pivotal is because I see inflation starting to rise to the highest point of this cycle as growth also increases to the highest point in the cycle, backed by the tax cut.

Now let’s look at the details of the report. Month over month rents increased 0.4% and owner’s equivalent rent of a primary residence increased 0.3%. Medical costs increased 0.3% and prescription drug prices increased 1.0%. Hospital and doctor visit costs were up 0.3%. This healthcare price inflation is not what the Fed is looking for. The healthcare economy is inefficient. It’s unlikely that the increased spending is going to workers or research and development; it usually goes to administration costs. There are some companies which are able to increase drug prices without innovating because they are exploiting a flaw in the insurance marketplace.

New car expenses were up 0.6% which was the largest increase since January. Car insurance was up 0.6% as well. Apparel costs were down 0.5% which is consistent with the past decade of stable prices in this area. To be clear, I mean prices which haven’t moved, not what the Fed describes as stable prices which is really a 2% increase every year.

Surprisingly, the main reason why the headline inflation didn’t follow the core inflation up is because gasoline prices were down 2.7% after increasing 7.3% in November. That performance doesn’t look like it will be replicated next month as the price of oil increased to a $64 handle on Friday which was the highest point in 3 years. The CRB commodities ETF is at $195.58 which is the highest point since October 2016. Food inflation accelerated as it went from being flat for 2 months to up 0.2% in December.

Retail Sales Were Great In December

While stocks have been on a massive run, it’s tough to blame investors for going overboard because the economic data and earnings have been great. One additional example of this was Friday’s retail sales report from December. Retail sales were up 5.4% year over year and 0.4% from last month. This great report is exactly what I was expecting. The November report was revised higher to show 0.9% growth month over month instead of 0.8%. For the year, sales were up 4.2% which was an acceleration from the previous year’s growth of 3.2%.

Breaking down the report, there was a 1.2% increase in sales at gardening and building material stores. Auto dealership sales were up 0.2%. Without food service, gas, and auto dealerships, retail sales were up 0.3% in December and 1.4% in November. The November report was revised higher from 0.8% which is a huge boost that will help Q4 GDP since this metric is related to the consumer spending part of the GDP report. Finally, electronics and appliance store sales declined 0.2%, clothing store sales fell 0.3%, online retail sales were up 1.2%, sporting goods store sales were down 1.6%, and restaurant and bar sales were up 0.7%.

The great retail sales report and the CPI report bolstered Q4 GDP estimates. The estimate for consumer spending growth from the Atlanta Fed increased from 3% to 3.8%. As you can see from the chart below, this caused the Atlanta Fed’s GDP Now to go from expecting 2.8% growth in Q4 to 3.3% growth. There will be 2 more updates to the GDP Now forecast before the January 26th advanced Q4 GDP report. As usual for this point in the quarter, this GDP Now estimate will be close to the final estimate. The advanced GDP report can vary widely from the final report. The full year growth in 2017 could become the fastest of this expansion if Q4 growth meets the most optimistic assumptions. As you can see, the blue chip estimate has fallen to 2.6% lately, so not everyone sees the world through rose colored lenses.