Said Daly, this “pop” was expected
But basically, we have projected
This only will last
A few months, then pass
Thus, higher rates we have rejected
Said Bullard, it may well be time
To alter QE’s paradigm
By end of this year
It ought to be clear
That tapering is not a crime
And finally, today Chairman Jay
Is like to have something to say
‘Bout why rising prices
Do not mean a crisis
Is brewing and soon on the way
The one thing about writing this note on a daily basis is that you really get to see the topic du jour. In fact, arguably, that is the purpose of the note. When Brexit happened in 2016, it was likely the topic of 75% of my output. Covid dominated last year for at least 3 months, where virtually every discussion referenced its impact. And now we are onto the next topic which just will not go away. In fact, if anything it is growing in importance. Of course, I mean inflation.
By now you are all aware that June’s CPI reading was 5.4% on a headline basis and 4.5% ex food & energy with both readings substantially higher than forecasted by the punditry. The monthly gains in both series was 0.9%. Now my rudimentary math skills tell me that if I annualized 0.9%, I would wind up with an inflation rate of 11.4%. I don’t know about you, but to me that number represents some real problems. Of course, despite the reality on the ground, the FOMC cannot possibly admit that their policies are driving the economy into a ditch, so they continue to spin a tale of transitory price gains that are entirely due to short-term impacts on supply chains and gains relative to last year’s extremely depressed prices on the back of Covid inspired lockdowns. And while, last year’s Covid-inspired lockdowns did have a major negative impact on prices, the idea that supply chain disruptions are short-term are more an article of faith, based on economic textbook theories, than a description of reality.
In addition, the other key leg of the Fed thinking is that inflation expectations remain ‘well-anchored.’ Alas, I fear that anchor may have come loose and is starting to drift with the current of inflation prints to a higher level. This was made evident in the NY Fed’s survey of inflation expectations released on Monday showing that people expected inflation to be 4.8% in one year’s time. The Fed also likes to point to inflation breakevens in the market (the difference between nominal Treasury yields and their TIPS counterparts) and how those have fallen. It is true, they are lower than we saw at the peak in mid-May (2.56%), but in the past week, they have risen 15 basis points, to 2.37%, and appear to be headed yet higher.
And this is not merely a US phenomenon. For instance, just this morning CPI in the UK printed at 2.5%, rising a more than expected 0.4% from last month, and we have seen this occur around the world, as both developed countries (e.g. Germany, Canada and Spain) and developing nations (e.g. Brazil, India and Mexico) have all been suffering from prices rising faster than expected. Now, there are some nations that are addressing the issue with monetary policy by tightening (Brazil, Mexico and Hungary being the latest). But there are others that continue to whistle pass this particular graveyard and remain adamant there is no problem (US, UK Europe).
Chairman Powell testifies to the House today (my apologies for mistakenly explaining it would be yesterday) and it has the opportunity to be quite interesting. While there will not doubt be a certain amount of fawning by some members of the committee, at least a few members have a more conservative bent and may ask uncomfortable questions. I keep waiting to hear someone ask, ‘Chairman Powell, can you please explain why you believe my constituents are better off when paying higher prices for the items they regularly purchase? After all, isn’t that what Fed policy to raise inflation is all about?’ Alas, I don’t expect anyone to be so bold.
In the end, based on a lot of history, Powell will never directly answer a question on inflation other than to say that it is transitory and that the current monetary policy settings are appropriate. If pressed further, he will explain the Fed “has the tools” necessary to combat inflation, but it is not yet time to use them. While it is possible he has a Freudian slip and reveals his true thinking, he has become pretty polished in these affairs and the audience is generally not sharp enough to throw him off his game.
To sum it all up, inflation is
screaming higher rising rapidly and the Fed remains sanguine and unlikely to adjust their policies in the near future. While Daly and Bullard, two doves who spoke yesterday, indicated that tapering QE would likely be appropriate at some point, there was no evident hurry in their views. Consumer prices are going higher from here, count on it.
There are some nations, however, that are willing to address inflation. We already see several raising rates and last night, the RBNZ explained they would be ending QE by next week. This was quite a surprise to the market and so we saw 10-year yields in New Zealand jump 7.3 basis points while NZD (+1.0%) has been the best performing currency in the world as expectations are now that the RBNZ will begin raising rates by the end of the summer. But that the Fed had this type of common sense.
Ok, enough ranting on inflation. Let’s see how this string of higher CPI prints has been impacting markets. On the equity front, it has not been a happy period. Yesterday saw US markets sell off, albeit only in the 0.3%-0.4% range. But Asia was far worse (Nikkei -0.4%, Hang Seng -0.6%, Shanghai -1.1%) and Europe is entirely in the red as well (DAX -0.2%, CAC -0.25%, FTSE 100 -0.6%) with the UK leading the way lower after that CPI print. US futures, though, have had enough of the selling and are very modestly higher at this time. Perhaps they think Powell will save the day.
Did I mention the 30-year bond auction was a disaster yesterday? Apparently, with inflation running at 5.4%, locking in a yield of 1.975% for 30-years does not seem very attractive to investors. Hence, the abrupt move to 2.05% after the auction announcement, with a long tail. While yields are a touch lower this morning (10-year -2.0bps, 30-year -2.6bps) that has more to do with the jettisoning of equity risk than a desire to earn large negative real returns. In Europe, it should be no surprise that Gilt yields are higher, +3.6bps, after the CPI print, but the continent is largely unchanged on the day.
Oil prices have backed off a bit, falling 0.8% this morning, but WTI remains just below $75/bbl and the trend is still firmly higher. Gold is perking up a bit as declining real yields always helps the barbarous relic and is higher by 0.5% with silver +0.8%. Base metals, however, are in a different place with Cu (-0.75%) and Al (-0.5%) leading the way lower. Foodstuffs are generally higher, which of course explains the ongoing unrest in a growing list of developing countries.
As to the dollar, it is broadly weaker vs. its G10 counterparts, with kiwi far and away the leader while the rest of the bloc is firmer by between 0.1%-0.3%. That feels much more like a dollar consolidation than any other stories beyond NZD and GBP’s inflation print. In the EMG bloc, the picture is more mixed with PHP (-0.6%) the laggard as capital continues to flow out of the country amid foreign reserve levels sinking. The rest of the APAC bloc was also soft, but much of that came yesterday in NY’s session with little adjustment from those levels. On the plus side, MXN (+0.3%) is the leading gainer and the CE4 are all higher by about 0.2%, but this remains dollar consolidation after a run higher.
Somewhat anticlimactically we are going to see PPI this morning (exp 6.7%, 5.1% ex food & energy), but given the CPI has already been released, it will have to be really special to have an impact. The Fed’s Beige Book is released at 2:00 but the highlight will be the Chairman at noon. Frankly, until then, I don’t expect very much at all, but the market will be hanging on every word he speaks.
Broadly, the dollar remains well bid. Yesterday saw the market anticipate the Fed being forced to tighten sooner than previously expected. Powell has the opportunity to squelch that view or encourage it. While I believe he will lean toward the former, that is the key market risk right now. If I were a hedger, I would think about getting things done this morning, not this afternoon.
Good luck and stay safe