As markets await CPI
It’s funny to watch the Fed try
Explaining inflation
Will lack the duration
To send expectations sky-high

But even their own surveys show
That most people already know
Inflation is here
And well past next year
The level of prices will grow

Each month the Federal Reserve Bank of New York publishes the results of a survey of consumer expectations on inflation.  Yesterday, they published the September results and, lo and behold, the data showed that 1-year inflation expectations rose to 5.31%, by far the highest point since the survey began in 2013.  The 3-year data rose to its highest ever level of 4.19%, also well above the Fed’s 2.0% target.  And yet somehow, the authors of the report explained that inflation expectations remain well anchored.  Their claim is that if you look at the 5-year expectations, they remain near the levels seen before the pandemic, indicating that there should be no concern.  I don’t know about you, but 3 years of inflation running above 4.0% seems a lot longer than transitory.

Of course, it’s not just the analysts at the NY Fed who are unwilling to admit to the increasingly obvious situation, we continue to hear the same from other officials.  For instance, Treasury Secretary Janet Yellen, in a televised interview yesterday remarked, “I believe it’s [inflation] transitory, but I don’t mean to suggest these pressures will disappear in the next month or two.”  She then raised the specter of shortages by commenting, “There’s no reason for consumers to panic over the absence of goods they’re going to want to acquire at Christmas.”  Now, don’t you feel better?

In fairness, however, there are several Fed members who have finally admitted that the transitory emperor has no clothes.  Atlanta Fed President Raphael Bostic explained yesterday, “It is becoming increasingly clear that the feature of this episode that has animated price pressures – mainly the intense and widespread supply-chain disruptions – will not be brief.  By this definition, then, the forces are not transitory.”  As well, we heard from St Louis Fed President James Bullard, “I have to put some probability on a scenario where inflation stays high or even goes higher.”

At this point, it’s fair to ask, which is it?  Clearly there is a split at the Fed with some regional presidents recognizing that inflation has risen sharply and has all the appearances of being persistent, while Fed governors seem more likely to lean toward the transitory fable.  Perhaps what explains this split is the regional presidents have a far different constituency than do the Fed governors.  The Fed presidents are trying to address the issues extant in their respective geographies, so rising inflation matters to them.  Meanwhile, the governors, despite the claim that the Fed is apolitical, serve their masters in Congress and the White House, who believe they need to continue QE and ZIRP forever to continue spending money in unconscionable sums while not suffering from the slings and arrows of the bond market vigilantes.  But remember this too, every Fed governor votes at every meeting while only a handful of regional presidents vote (granted, Bostic is one of those right now.)  I fear we will continue to hear transitory for a while yet.

All this is a prelude to two key pieces of information today, this morning’s CPI release (exp 5.3% headline, 4.0% core) and the FOMC Minutes from the September meeting to be released at 2:00pm.  The one thing that has been very clear lately is that interest rate markets are beginning to buy into the persistence of inflation.  While Treasury yields have edged lower by 1.6bps this morning, in the past 3 weeks, those yields have risen 26 basis points.  And this is a global phenomenon with Bund yields, for instance, having risen 20 basis points over the same period despite a 4.1bp decline today.  Investors are starting to pressure the central bank community with respect to interest rates, driving them higher as fears of rising inflation abound worldwide.  While some, central banks have recognized the reality on the ground (Norway, New Zealand, numerous EMG nations) and others have paid lip service to the idea of raising rates (the UK, Canada), the two biggest players, the Fed and ECB, will not even discuss raising rates, although the Fed continues to tease us with talk of tapering.

However, I will ask again, do you believe the Fed will taper (tighten) policy if GDP growth is more clearly abating?  My view remains that they may actually start to taper, but that it will be a short-lived process as weak GDP growth will dissuade them from doing anything to worsen that side of the ledger.  While eventually, weaker GDP growth will result in demand destruction and reduced price pressures, that is likely to take a very long time.  Hence, the idea of stagflation remains very viable going forward.

Now it’s time to look at markets.  Equities have had a mixed session thus far with Asia (Nikkei -0.3%, Hang Seng -1.4%, Shanghai +0.4%) seeing both gainers and losers and Europe (DAX +0.7%, CAC +0.25%, FTSE 100 -0.1%) seeing similar mixed price action.  UK data showed August GDP was a tick lower than forecast and is clearly slowing from its previous pace, arguably weighing on the FTSE.  As to US futures, they are edging higher ahead of the data with gains in the 0.1%-0.3% range after yesterday’s modest declines.

We’ve already discussed bonds so a look at commodities shows that oil (-0.6%) is retreating for the moment as is NatGas (-1.5%), while we are seeing strength in gold (+0.7%) and copper (+1.7%).  In fact, the entire metals complex is stronger today as apparently, weaker energy prices are good for industrial activities.

As to the dollar, it is under some modest pressure today across the board.  In the G10, SEK (+0.35%) and CHF (+0.35%) lead the way with JPY (0.0%) the laggard.  However, there are no specific stories that seem to be driving things, rather this is a broad-based dollar correction from recent strength.  The same situation holds in the EMG bloc with ZAR (+0.75%) the leader followed by much lesser movement of KRW (+0.4%), CZK (+0.35%) and PLN (+0.35%).  The won has responded to comments from the central bank that it is closely watching the exchange rate and will not be afraid to step in if it becomes destabilized.  That is a euphemism for much weaker, as the currency had fallen nearly 9% in the previous four months.  As to the others, recent weakness seems to merely being consolidated with nothing new driving price action.

While the Fed may not care much about CPI, the rest of us do care.  And really, so do they, but it doesn’t tell their story very well.  At any rate, while it is entirely reasonable that we see a continued flatlining of price rises, the risks remain to the upside as at some point, housing inflation is going to show up in the data.  And that, my friends, is going to be significant and persistent!  Ahead of the number, don’t look for much.  If we see a high print, expect the dollar to regain this morning’s losses, though, as the market will become that much surer the taper is on its way.

Good luck and stay safe
Adf