A Simple Statistic

There once was a simple statistic
That people used as a heuristic
Of whether or not
The things that they bought
Cost more as a characteristic

But central banks worldwide decided
That view about costs was misguided
Instead they created
A world that inflated
The price of most all things provided

The market’s (and this author’s) virtual obsession with inflation continues and will receive the latest important data point at 8:30 this morning.  At that time, CPI will be released with the following median forecasts according to Bloomberg:

CPI MoM 0.5%
-ex food & energy MoM 0.2%
CPI YoY 2.5%
-ex food & energy YoY 1.5%

The last time CPI printed as high as 2.5% was January 2020, and prior to that it was October 2018.  As I wrote yesterday, the fact that the comparison on a YoY basis is so incredibly low due to the initial government lockdowns last year at this time, mathematically, this number is destined to be high.  After all, last month CPI YoY printed at 1.7%, so this is a big jump.  We also know that the Fed has made it clear that not only do they understand base effects, so will not get excited by today’s print regardless of its outcome, but that they remain essentially unconcerned about rising inflation anyway as they have interpreted their dual mandate to mean maximum employment at all costs.  Oh yeah, they don’t even consider CPI a worthy statistic for their own models, instead preferring Core PCE, which has a somewhat different philosophical background as well as a substantially different makeup as to the weights it assigns to the various items in its basket of goods and services.

Markets, however, do care about CPI as it appears to do a better job of reflecting the state of prices than PCE, and perhaps more importantly, CPI is the actual number used in most inflation adjusted products, notably TIPS and Social Security’s COLA.  My good friend Mike Ashton (@inflation_guy) is actually the best source of information on the topic and you should all follow him on Twitter as he produces thoughtful commentary on CPI the day of its release, breaking down the data.  What I have gleaned from his recent commentary is that there are many more things pointing to sustainably higher prices than simply the base effects of the calculation.  And I can’t help but notice how the price of things that I buy seem to continue to rise as well.  While the plural of anecdote is not data, at some point, enough anecdotes about higher prices has to have meaning.  Whether it is the cost of plywood, or a meal at your favorite restaurant or that bottle of ketchup at the supermarket, I am hard pressed to find anything that has fallen in price.  Certainly not gasoline, and even tech items cost more.  If you need a new laptop, while the hedonic adjustments made by the BLS may make theoretical sense, the reality is it still costs more dollars (or euros or yen) to actually walk out of the store with the new computer.

Alas, Chairman Powell and his band of Merry Men (and Women) have made it abundantly clear that rising prices are not of interest now or in the near future.  In fact, given the Fed’s current stance, why would they even discuss the idea of tapering QE at all.  If rising prices don’t matter, then lower interest rates will be a permanent support for the economy and offer the best insurance that not only will maximum employment be achieved but maintained.

Of course, there is the little matter of the Treasury bond market to contend with, as investors may have qualms over the interest rate at which they will lend to the US government in the face of rising prices.  We are all aware of how much Treasury yields have risen this year, especially in the 10-year and 30-year maturities.  Those higher yields are a result of both rising inflation concerns as well as significantly greater issuance.  Yesterday, for instance, the Treasury issued a total of $96 billion in new debt, $58 billion of 3-year and $38 billion of 10-year.  The 10-year auction results were about average, except for the fact that the yield they are paying, 1.68%, is more than 50 basis points higher than the average of the previous 5 auctions.  Remember, a key tenet of the Yellen Treasury is that they can afford to borrow much more since the debt service costs are so low.  However, if yields continue to rise, those debt service costs are going to rise with them, so this is not a permanent situation.

Tying it all together, despite the Fed’s current obsession with employment and its corresponding indifference to inflation, the inflation debate will not go away anytime soon.  This morning will simply be the latest volley in the ongoing ‘war’ between central banks and reality.  In the end, I’m confident reality will win, but the central banks have made it clear they will not go down without a fight.

As to markets this morning, after a very dull session yesterday, things remain quiet as this data point continues to be the global market focus.  So equity markets have been mixed in Asia (Nikkei +0.7%, Hang Seng +0.1%, Shanghai -0.5%) and Europe (DAX +0.1%, CAC +0.2%, FTSE 100 -0.1%) with US futures actually starting to slide as all three major indices are now lower by 0.4%-0.5% as I type.

Bond markets are modestly softer with Treasury yields higher by 0.5bps, and similar rises in the major European sovereign markets.  The PIGS are having a tougher day here, with Italy (+2.9bps) and Greece (+4.3bps) selling off a bit harder.  We also saw yields rise in Australia overnight.

Yesterday morning I mentioned oil’s struggle at $60/bbl and it continues as while prices are higher compared to yesterday’s close (WTI +0.75%), the price is right on that big round number, which tells us it fell back in yesterday’s session from early morning gains.  Metals markets are similarly mixed (Au -0.2%, Ag +0.6%, Cu +0.2%, Sn -0.3%) and it can be no surprise that grain markets have traded the same way.  In other words, pretty much every market is waiting for CPI to take their cues.

FX markets are starting to bias toward dollar strength as NY walks in, with NOK (-0.75%) the laggard in the G10, although on precious little news or data.  This is especially odd given oil’s gains in the session.  But pretty much the entire G10 is softer, albeit with less emphasis than the krone, as CAD (-0.45%) is the next worst performer and then the rest are simply drifting lower ahead of the number.  EMG markets are also biased toward USD strength here, with PLN (-0.8%) and HUF (-0.65%) the two outliers, both on the back of commentary that ongoing easy monetary policy remains appropriate and the central banks are comfortable with the weaker currencies.

The CPI data is the only release, but we will hear from 6 more Fed speakers today as pretty much all members of the FOMC are on the calendar this week.  Yesterday’s most notable comments came from St Louis Fed President Bullard as he floated a tapering trial balloon, hinting that when 75% of the population has been vaccinated, that might be an appropriate time to consider that option.  While it is clear that is Bullard’s proxy for a return to economic growth, it seems an odd data point on which to base monetary policy decisions, as the relationship between vaccinations and economic activity is not that direct.

At any rate, nothing has changed with respect to markets with 10-year Treasury yields remaining the key driver.  If today’s CPI is strong, and yields rise, look for the dollar to continue to rise as well, with a weak print, and lower yields likely softening the buck.  These days, it is truly binary.

Good luck and stay safe
Adf