The data released yesterday
Had Fed speakers try to downplay
The idea that prices
Are causing a crisis
They said, don’t get carried away
But markets worldwide have all swooned
As traders are highly attuned
To signals inflation
In every location
Will quickly show that it’s ballooned
Wow! That’s pretty much all you can say about the CPI data yesterday, where, as I’m sure you are by now aware, the numbers were all much higher than expected. To recap, headline CPI rose 0.8% M/M which translated into a 4.2% Y/Y increase. Ex food & energy, the monthly gain was 0.9%, with the Y/Y number jumping to 3.0%. To give some context, the core 0.9% gain was the highest print since 1981. It appears, that at least for one month, the combination of unlimited printing of money and massive fiscal spending did what many economists have long feared, awakened the inflation dragon.
The Fed was in immediate damage control mode yesterday, fortunately having a number of speakers already scheduled to opine, with Vice-Chair Richard Clarida the most visible. His message, along with all the other speakers, was that this print was of no real concern, and in truth, somewhat expected, as the reopening of the economy would naturally lead to some short-term price pressures as supply bottlenecks get worked out. As well, they highlighted the fact that much of the gain was caused by just a few items, used car prices and lodging away from home, neither of which is likely to rise by similar amounts again next month. That may well be true, but the elephant in the room is the question regarding housing inflation and its relative quietude.
House prices, at least according to the Case Shiller Index, are screaming higher, up 12% around the country in the past 12 months and showing no signs of slowing down. The pandemic has resulted in a significant amount of displacement and as people move, they need some place to live. The statistics show that there is the smallest inventory of homes available in decades. As well, the rocketing price of lumber has added, apparently, $34,000 to the price of a new house compared to where it was last year, which given the median house price in the US is a touch under $300,000, implies a more than 10% rise in price simply due to the cost of one material. And yet, Owners Equivalent Rent, the housing portion of the CPI data, rose only at 0.21% pace. A great source of inflation information is Mike Ashton (@inflation_guy), someone you should follow as he really understands this stuff better than anyone else I know. As he explains so well, this is likely due to the eviction moratorium that has been in place for more than a year, so rents paid have been declining. However, that moratorium has just been overturned in a court decision and so we should look for the very hot housing market to soon be reflected in CPI. That, my friends, will be harder to pass off as transitory.
The reason all this matters is because the entire Fed case of maintaining ZIRP in their efforts to achieve maximum employment, is based on the fact that inflation is not a problem, so they have no reason to raise rates. However, if they are wrong on this issue, which is the only issue on which they focus, it results in the Fed facing a very difficult decision; raise rates to fight inflation and watch securities prices deflate dramatically or stay the course and let inflation continue to rise until it potentially gets out of control. While we all know they have the tools, the decision to use them will be far more challenging than I believe most of them expect.
The market’s initial reaction to the data was a broad risk-off session, as equity prices fell sharply in Europe and the US yesterday and then overnight in Asia (Nikkei -2.5%, Hang Seng -1.8%, shanghai -1.0%) they followed the trend. Europe this morning (DAX -1.4%, CAC -1.1%, FTSE 100 -2.0%) is still under pressure as the global equity bubble is reliant on never-ending easy money. Rising inflation is the last thing equity markets can abide, so these declines can not be surprising. The question, of course, is will they continue? A one- or two-day hiccup is not really a problem, but if investors start to get nervous, it is a completely different story. It is certainly true that valuations for equities, at least as measured by traditional metrics like P/E and P/S are at extremely high levels. A loss of confidence that the past is prologue could well see a very sharp correction.
Despite the risk off nature of the equity market price action, bonds were also sold aggressively yesterday and in the overnight session. It ought not be surprising given that bonds should be the worst performing asset in an inflationary spike, but still, the 10-year Treasury jumped more than 7 basis points yesterday, a pretty big move. While this morning it is essentially unchanged, the same cannot be said for the European sovereign market where yields have risen again, between 1.5bps (Bunds) and 5.1bps (Italian BTPs) with the rest of the continent sandwiched in between. Nothing has changed my view that the 10-year Treasury yield remains the key market driver, at least for now, thus if yields continue to rally, look for more downward pressure on stocks and commodities and upward pressure on the dollar.
Speaking of commodities, they are under pressure across the board this morning with WTI (-2.1%) leading the way lower but Cu (-1.7%) having its worst day in months. The entire base metal complex is lower as are virtually all agriculturals, although the precious metals are holding up as a bit of fear creeps into the investor psyche.
Finally, the dollar, which rallied sharply yesterday all day in the wake of the CPI print, is more mixed this morning gaining against the G10’s commodity bloc (NOK -0.3%, AUD -0.2%) while suffering against the European bloc (CHF +0.25%, EUR +0.1%) although the magnitude of the movements have been small enough to attribute them to modest position adjustments rather than an overriding narrative. We are seeing a similar split in the EMG currencies, with APAC currencies all under pressure (THB -0.5%, KRW –0.4%, TWD -0.2%) while the CE4 hold their own (PLN +0.3%, HUF +0.3%, CZK +0.2%). At this time, LATAM currencies, which all suffered yesterday, are either unchanged or unopened.
This morning’s data brings Initial Claims (exp 490K) and Continuing Claims (3.65M) as well as PPI (0.3% M/M, 5.8% Y/Y) headline and (0.4% M/M, 3.8% Y/Y ex food & energy). Of course, with the CPI already out, this is unlikely to have nearly the impact as yesterday. In addition, we get three more Fed speakers to once again reiterate that yesterday’s CPI data was aberrational and that any inflation is transitory. I guess they hope if they say it often enough, people may begin to believe them. But that is hard to do when the prices you pay for stuff continues to rise.
Treasuries remain the key. If yields rally again (and there is a 30-year auction today) then I expect the dollar to take another leg higher. If, on the other hand, yields drift back lower, look for the dollar to follow as equity buyers dip their toes back into the water.
Good luck and stay safe