Inflation continues to be
The problem the Fed will not see
The latest report
Shows nothing will thwart
Their views that it’s transitory
Perspective is a funny thing; it has the ability to allow different people to see the same events in very different ways. For example, yesterday’s CPI report, which printed at 5.4% headline and 4.3% ex food & energy, was fodder for both those with an inflationary bias and those who are in the transitory camp. As predicted here yesterday morning, any number that was not higher than the June report would be touted as proof inflation is transitory. And so it has been. The highlighted facts are the month on month reading was ‘only’ 0.5%, much lower than the previous three months’ readings of 0.9%. Of course, that is true, but it ignores the fact that a monthly rate of 0.5% annualizes to 6.16%, still dramatically higher than the target. As well, there was much ink spilled on the fact that used car prices, which had admittedly been rising remarkably quickly due to the unusual circumstances of the semiconductor shortage impeding new car production, fell back to a more normal pace of growth. The problem with that story is despite one of the ostensible key reasons inflation had been misleadingly higher, used car prices, ceasing to be an issue, inflation still printed at 5.4%! Clearly there are other things at work here.
Another aspect of perspective comes in the form of the averaging concept, which is the Fed’s latest ruse in rationalizing higher inflation. For instance, those in the transitory camp, which seems to include the entire FOMC, but also much of the punditry, remain hostile to the idea of inflation settling in at a rate of 1.8%, slightly below the Fed’s target, but are entirely sanguine about that same statistic running at 2.8% for a while to help make up for lost time. It is this distorted lens that seems to drive the description of inflation as ‘too-low’. From up here in the cheap seats, inflation cannot be too low. The idea that we are all better off with prices rising is wrong on its face.
And the idea that wage increases drive inflation also needs to be reconsidered. After all, if that were the case, we would all be rooting for inflation as that means our wages would be rising quickly. However, as we know simply by living our lives, and as has been demonstrated by the data, wage increases are broadly lagging inflation. In fact, yesterday, as part of the Bureau of Labor Statistics data dump, Real Average Hourly and Weekly Earnings showed Y/Y declines of -1.2% and -0.7% in July. It is no secret that inflation destroys the real value of your earnings, and yet the Fed continues to target a higher level of inflation than had been seen during the past decade and remains comfortable that the current sharply higher numbers are inconsequential in the long run.
However, in the end, whether we agree or disagree with the Fed’s current policy stance and its impacts, the reality is we are not going to have any say in the matter. All we can do is strive to understand their reaction functions and manage our risks accordingly. Ultimately, I continue to see the biggest risk as a significantly higher rate of inflation in the US, which will eventually drive nominal yields somewhat higher and real yields still lower than current levels. That cannot be good for the dollar but will likely help the prices of ‘stuff’. In the end, be long anything on the periodic table, as that will maintain its value.
The summer doldrums continue as market movement remains fairly limited across equities, bonds, commodities and currencies. This is not to say there aren’t individual things that move or are trending, just that the broader picture is one of a decided lack of activity.
Last night, for instance, Asian equity markets (Nikkei -0.2%, Hang Seng -0.5%, Shanghai -0.2%) were all lower, but only just. European markets are more mixed, with both gainers (DAX +0.4%, CAC +0.2%) and losers (FTSE 100 -0.1%) but as can be seen, the movements are not terribly exciting. This morning saw the release of a plethora of UK data led by Q/Q GDP (+4.8%) and then many of its details showing Consumption by both the government and the population at large grew dramatically, while businesses slowed down somewhat, with IP and Construction both lagging estimates. I guess investors were generally unimpressed as both the stock market and the pound (-0.1%) have edged somewhat lower after the reports. Finally, US futures are either side of unchanged again, with the NASDAQ continuing to lag in the wake of the recent rise in US 10-year yields.
Speaking of yields, after the very sharp rise seen in the previous five sessions, yesterday’s Treasury price action was far less exciting and this morning we see the 10-year yield higher by just 1.0 basis point after a decline of similar magnitude Wednesday. European sovereigns show Bunds (+0.8bps) and OATs (+0.7bps) modestly softer while Gilts (+2.5bps) seem to believe that the UK data was actually better than other market impressions.
Commodity prices are mixed this morning as oil (-0.2%) has given up early gains, along with gold (-0.1%) and the agricultural space. Copper, however, is bucking the trend and higher by 0.8%.
Lastly, the dollar can only be characterized as mixed this morning, with some weakness in AUD and NZD (-0.25% each) and some strength in NOK (+0.2%) and otherwise a lot of nothing in between. It is hard to make a case that there is much market moving news in any of these currencies as the UK was the only country with significant new information.
Emerging market currencies are also split, with KRW (-0.4%) continuing to lag the rest of the space as concern grows over the semiconductor manufacturing sector leading to continued equity market outflows and currency sales. I would imagine that the recent rantings by Kim Jong-Un’s little sister about increased nuclear activity cannot be helping the situation there, but it is not getting headline press in financial discussions. Otherwise, PLN (-0.3%) is the next weakest currency in the bloc today which seems to be a reaction to some legislation passed that would ostensibly restrict media and speech in the country. On the plus side, TRY (+1.0%) is today’s champion as traders and investors respond to the central bank’s moderately more hawkish than expected statement after leaving interest rates unchanged (at 19.0%!) as widely expected. Otherwise, there is nothing noteworthy in the space.
Data today brings the weekly Initial Claims (exp 375K) and Continuing Claims (2.9M) data as well as PPI (7.2%, 5.6% ex food & energy). However, with CPI already having been released, this data seems relatively insignificant. There are no scheduled Fed speakers as most FOMC members seem to be going on vacation ahead of the Jackson Hole conference in two weeks’ time.
For now, the dollar seems to be tracking yields pretty well, so if we see movement in the bond market, look for the dollar to follow. Otherwise, we are likely to remain rangebound for the time being.
Good luck and stay safe