Leading Indicators Signal Slowdown Will Continue

The most important aspect of the economy is inflation because low inflation allowed the Fed to turn dovish which helped reverse last year’s bear market. If the Fed would have set guidance for 3 hikes in 2019, stocks may not have recovered, and the yield curve may have inverted. The great news for the economy is the Phillips curve is broken. To be clear, the Phillips curve says low unemployment drives high inflation. Low unemployment has helped wage growth, but wage growth hasn’t driven inflation. One of the biggest impacts to core inflation has been YoY comparisons of previous periods as the rate of change hasn’t been able to stay above 2% for any sustained period in this expansion.

The next big inflation report is PCE which comes out on March 1st. If inflation spikes, the Fed will need to hike rates again which might not be handled well by stocks and the economy because it is still in a slowdown. There are some green shoots in the housing market (falling interest rates & strong wage growth) which can lead to a strong spring selling season. While that could boost GDP growth, house price growth will generate more inflation. It’s a double-edged sword. While the housing slowdown hurt the economy in 2018, the modest decline in price growth helped limit inflation.

Commodity prices impact inflation. We like to see a strong demand for commodities because it means the economy is growing, but too much of a good thing increases inflation. Even though the global economy is in a slowdown, commodities have been rallying along with stocks in 2019. As you can see from the chart below, the CRB commodity index is up 8.02% year to date.

It’s still down 11.13% from its 2018 high. The more it increases, the more likely the Fed is to raise rates. The Fed had an easy decision to turn dovish at the end of December because inflation was slow and growth was falling. It could have a tough decision if growth falls in the next few months, while inflation rises. 

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