Investing Insights

INFLATION WATCH  •  January 20, 2025  •  Jon Wolfenbarger

Small Business Optimism Soars, But Inflation Remains High

MILWAUKEE, WI — The NFIB survey of small business owners shows that small business optimism continues to rise on Trump’s expected pro-business policies. The NFIB Small Business Optimism Index rose to 105.1 in December. That is the second consecutive month above the 51-year average of 98 and the highest level since October 2018.

According to NFIB Chief Economist Bill Dunkelberg:

“Optimism on Main Street continues to grow with the improved economic outlook following the election. Small business owners feel more certain and hopeful about the economic agenda of the new administration. Expectations for economic growth, lower inflation, and positive business conditions have increased in anticipation of pro-business policies and legislation in the new year.”

As the chart below shows (courtesy of NFIB), “hard” components of the Optimism Index such as job creation plans, earnings and capital expenditure plans (dark line) generally remain weak, while “soft” components like expected business conditions, outlook for expansion and expected real sales (gray line) have skyrocketed since the election from levels that were even lower than during the Great Recession. If those soft measures of small business optimism were wrong at those low levels, will it be right now at these higher levels? We shall see.

Small business earnings have been in a general downtrend since 2018, as shown below. A net negative 26% of small business owners reported positive profit trends in December, the same as November.

Similarly, a net negative 13% of owners reported higher sales trends, unchanged from November, as this chart shows. However, the net percentage of owners expecting higher real sales increased by 8 points to a net 22%. That is the highest reading since January 2020, just before sales collapsed due the covid panic.

Employment trends remain down, although employment plans are starting to rise, as shown here.

Note that overall real retail sales for all businesses rose 1% in December. Real retail sales have been flattish for almost three years, as this chart shows.

Inflation Is Still The #1 Problem

According to the NFIB survey, a net 24% of small business owners are raising their prices, which was unchanged from November. A net 20% said that inflation is still their single most important problem, unchanged from November and leading labor quality as the number one issue.

As shown below, Consumer Price Inflation (CPI; blue line) rose from 2.8% in November to 2.9% in December, the highest level since July. Core CPI ex food and energy (red line) fell from 3.3% to 3.2%. However, going out to three decimal places, Core CPI ticked down from 3.300% to 3.248% July/August, so it was a very small change and that is still 60% higher than the Fed’s 2% target. SuperCore CPI (green line) ticked down from 4.1% to 4.0%, which is double the Fed’s target. 

As shown below, the Producer Price Index (PPI; blue line) rose from 3.0% in November to 3.3% in December. Core PPI excluding volatile food and energy prices (red line) ticked up from 3.48% to 3.54%. These are the highest levels in nearly two years.

PPI typically leads CPI, since consumer goods producers pass along higher input costs. As this chart shows with the red circles, when PPI growth (blue line) rises above or falls below CPI growth (red line), that typically leads changes in the CPI. Since PPI growth recently rose above CPI growth, that suggests higher inflation ahead.

The Fed has cut the Federal Funds rate to match short-term (3-Month, 1-Year and 2-Year) Treasury rates, as shown below. Since the Fed follows market rates when setting the Federal Funds rate, the Fed is not likely to change rates unless market yields move materially higher or lower. In addition, the fact that short-term rates have fallen over the past six months suggests the economy is weakening.

Investment Implications

Despite continued weak sales and earnings trends, stubbornly high inflation and the Fed likely having stopped rate cutting for now, small business owners are increasingly optimistic due to expectations of a more business-friendly environment under the new Trump administration. We are hopeful, but given the poor track record of politicians delivering on their campaign promises, there are no guarantees on government policies.