This morning we got May inflation data, and it was something of a wakeup call, because it was a reminder that inflation still existed.
Core CPI — which excludes food and energy prices — grew at its fastest month-over-month pace since 2011. On an annual basis, May was the hottest month since early 2013.
As you can see from the last three bars, inflation is clearly gathering steam.
Now we said up top that the reading was a wake-up call, but actually that’s not right. The signs have been showing up all over the place that the economy is gathering steam and pricing pressure is rising.
In a note published exactly a month ago, UBS economist Drew Matus highlighted two great charts.
Matus provides his own explanation of the charts that we’ve included, but the bottom line is that credit growth has begun to explode higher, and more and more firms are saying that wages are rising.
Since Matus published those charts, the trend of accelerating loan growth has continued.
Now the big questions are being asked: Is the economic breakout finally happening? And is the economy accelerating to the point where the Fed might consider?
In a note to clients yesterday, economist Chris Rupkey of Mitsubishi Financial argued unequivocally that the economic comeback is here. His comments were in relation to fresh numbers on industrial production and capacity utilization (emphasis ours):
Industrial production, the Fed’s own number, rising 0.6% today in the month of May, it is at all-time, record highs. Slack, what slack? This isn’t a recovery anymore, it is a full-on economic expansion. The old peak before the recession in this timely monthly measure of factory output was 100.8 in November 2007, now today it is up 0.6% in May to 103.7. This isn’t a recovery as production has already regained the ground lost in recession and keeps on moving higher and higher. Wait there’s more good news. Last month it fell a sharp 0.6% a number that made us scratch our heads for an explanation, but now we don’t have to explain, it is revised to down just 0.3% in April. To put it another way, production today at 103.7 is now 1.0% higher than the 102.7 level in last month’s report. The economy is 1% better than we knew it to be. Things are really hopping out there.
Goldman’s top economist Jan Hatzius recently conveyed similar thoughts, though in less excited tones when he said: “Despite the 1% drop in real GDP in the first quarter, we believe that the US economy is now growing at an above-trend pace.”
As for the Fed, remember it has a dual-mandate: To reduce unemployment and to get inflation up. Once the Fed hits its goals, it will inevitably start thinking about opportunities to tap on the breaks, and extricate itself from the Zero Interest Rate Policy (ZIRP) that has characterised its stance ever since the economic crisis.
And guess what, the Fed is closing in its goals. In his preview for this week’s Fed decision, economist Tim Duy pointed out that on both unemployment and inflation, the Fed doesn’t have much further to go to hit the endzone.
Regarding that second chart, the blue line or “NAIRU” is the level of unemployment where economists would expect to see accelerating inflation. The reason is that when unemployment gets low enough, workers really start to get wage and bargaining power, and that becomes the fuel for inflation. As you can see, we are getting very close.
So where does that leave us now?
Last week Bank of England chief Mark Carney warned that rate hikes might come sooner than the market currently expects. He was only talking about the UK economy and the BoE, but given that the UK experience mirrors ours in many ways, it’s inevitable that people have begun extrapolating about whether his comments are relevant here.
Tomorrow is FOMC day. Not only will the Federal Reserve announce its policy decision, Janet Yellen will have a press conference where she’ll be asked about all of this stuff.
In a note to clients today, economist Chris Rupkey succinctly explained what it’s all about: “Seems like the Fed needs to freshen up their guidance or start hiking rates earlier.”