I am sure you remember the lead up to Q1 2016. The US economy and stock market were transitioning from a Goldilocks environment and narrowly avoiding a bear market while the rest of the world was still battling deflation. Precious metals and commodities were in the dumper and try though US and global central banks might, they seemed to fail to woo the inflation genie out of its bottle at every turn.
Then came December of 2015 when gold and silver made bottoms followed by the gold miners in January of 2016. Then by the time February had come and gone the whole raft of other inflatables (commodities and stocks) had bottomed and begun to set sail.
As I listened to Mr. Powell speak about inflation yesterday my mind wandered back to Q1 2016 as I thought about the Fed trying to manage inflation at or around 2%. I also thought about how inflation tends to lift boats, not sink them. At least that is what it does in its earlier stages, in its manageable stages.
The balls out post-crisis inflation begun by Ben Bernanke was a massive market input and I suspect we have not yet seen its full effects – other than in US stock prices thus far. So dialing back to Q1 2016 let’s look at a few pictures, beginning with the Fed’s 10 year breakeven inflation rate, which bottomed… you guessed it, in Q1 2016. That means that ‘deflation expectations’ topped at that time.
Continue reading Inflation Trade, in Progress Since Gold Kicked it Off in Q1 2016
By Jeffrey Snider
What a difference a few months make. Perhaps given all that has happened since January people have regained some badly needed perspective. The core of inflation hysteria was the belief the economy was about to take off which would exacerbate underlying price pressures. That would necessitate more aggressive Federal Reserve reaction, corroborated by an epic bond market selloff.
Had last month’s CPI number been released, say, last November, it would have been hugely entertaining. According to the Bureau of Labor Statistics, the consumer price index for the month of May 2018 was 2.80% more than May 2017. This inflation rate bests the 2.74% posted in February 2017 as the highest since the 2.87% recorded for February 2012.
The predictable headlines about the “highest inflation in six years” would have at the end of last year set off a disturbed frenzy. Instead, this update with all the same comparisons is being met with a collective shrug; at most a reasonably toned-down if disappointing murmur.
The difference is economy and risk, often one and the same. Unlike in 2017, in 2018 the global economy has encountered numerous issues and even more “transitory” difficulties that are getting harder to overcome. Right at the front is the “dollar.” Again.
With economic reality setting back in, what’s really going on with US (and European) consumer prices is a bit clearer, though in truth it was always perfectly obvious. Oil and little else is behind these index spikes. It’s the rationalizations about them in the narrative form that no longer weigh so heavily.
Continue reading What A Difference A Few Months Make, Highest Inflation in Six Years And Market Shrugs
By Michael Ashton
Below is a summary of my post-CPI tweets.
- 27 minutes to CPI! Here are my pre-figure thoughts:
- Last month (April CPI) was a big surprise. The 0.098% rise in core was the lowest in almost a year, rewarding those economists who see this recent rise as transitory. (I don’t.)
- But underneath the headlines, April CPI was nowhere near as weak as it seemed. The sticky prices like housing were stronger and much of the weakness came from a huge drop in Used Cars and Trucks, which defied the surveys.
- Medical Care and Apparel were also both strong last month.
- Now, BECAUSE the weakness was concentrated in a small number of categories that had large moves, median inflation was still +0.24% last month, which drives home the fact that the underlying trend is much stronger than 0.10% per month.
- The question this month is: do we go back to what we were printing, 0.18%-0.21% per month (that’s the 2 month and 6 month avg prior to last month, respectively), or do we have a payback for the weak figure last month?
- To reiterate – there were not really any HIGH SIDE upliers to potentially reverse. Maybe housing a touch, but not much. To me, this suggests upside risk to the consensus [which is around 0.17% or so and a bump up (due to base effects) to 2.2% y/y].
- I don’t make monthly point forecasts, but I would say there’s a decent chance of an 0.21% or better…which number matters only since it would accelerate the y/y from 2.1% to 2.3% after rounding. So I agree with @petermcteague here, which is a good place to be.
- Note there’s also the ongoing risk each month of seeing tariffs trickle through or trucking pressures start to diffuse through to other goods prices. Watch core goods.
- So those are my thoughts. Put it this way though – I don’t see much that would cause the Fed to SLOW the rate hike plans, at least on the inflation side. Maybe EM or something not US economy-related, but we’d have to have a shockingly broadly weak number to give the FOMC pause.
- Starting to wonder why we even both with an actual release. Economists nailed it, 0.17% m/m on core, 2.21% y/y.
- That’s a 2.05% annualized increase. Which would be amazing if the Fed could nail that every month.
Continue reading Post-CPI Summary
By Kevin Muir
I have been banging on the inflation drum for so long I feel that even Todd Rundgren would be sick of hearing from me. While a couple of years ago, the majority of pundits were not talking about inflation – most were focused on the Fed’s inability to create rising prices in anything except financial assets – recently the market has awoken to the risks that accompany a decade of bat-shit-crazy central bank monetary policies.
With the current popularization of warnings about the coming inflation, I don’t know if I can add any value rehashing the points filling financial airwaves. The market seems to have finally caught on. Inflation is coming. In fact, it’s already here. And it will get a lot worse.
Instead of writing yet another piece reiterating my beliefs about why inflation will be a problem in the coming decades, I have decided to explore how market inflation expectations have changed over the past couple of years.
At the start of 2016, the market was pricing in a 1% 5-year breakeven inflation rate. That meant inflation had to average less than 1% for the next five years for nominal bonds to outperform TIPS (Treasury Inflation Protected Securities). Stop and think about that for a moment. The Federal Reserve has an inflation target of 2%. Yet the market did not believe they could achieve an inflation rate of even half their target.
The three Ds (deflation, demographics, and debt) were on everyone’s lips. It made little sense to invest in inflation-protected securities when everyone knew there could be no inflation.
Continue reading Thankful For Their Skepticism
By Michael Ashton
In this space I write a lot about inflation, but specifically I focus mostly on US inflation. However, inflation is substantially a global process – a paper by two ECB economists in 2005 (and our independent followup) found that nearly 80% of the variance in inflation in the G7 and G12 could be accounted for by a common factor. This observation has investment implications, but I’m not focusing on those here…I’m just presenting that fact to explain why I am about to show a chart of European inflation.
Right, so technically it’s my second article in a row in which I mention European inflation. In last Friday’s “Potpourri for $500, Alex”, I noted that core European inflation rebounded to 1.1% after being counted for dead at 0.7% last month. But what is illustrated above is the inflation swaps market, and so is forward-looking. I think this looks a lot more dramatic: investors expect 5-year European inflation to average 1.5% over the next 5 years (a year ago, they were at 1.1% or so and two years ago the market was at 0.7%), and to converge up towards 1.8% where the 5y, 5y forward inflation swap indicates the approximate long-run expectation since it’s not significantly influenced by wiggles in energy.
Continue reading European Inflation Concerns Also Rising?
By Michael Ashton
When I don’t write as often, I have trouble re-starting. That’s because I’m not writing because I don’t have anything to say, but because I don’t have time to write. Ergo, when I do sit down to write, I have a bunch of ideas competing to be the first thing I write about. And that freezes me a bit.
So, I’m just going to shotgun out some unconnected thoughts in short bursts and we will see how it goes.
Wages! Today’s Employment Report included the nugget that private hourly earnings are up at a 2.8% rate over the last year (see chart, source Bloomberg). Some of this is probably due to the one-time bumps in pay that some corporates have given to their employees as a result of the tax cut, and so the people who believe there is no inflation and never will be any inflation will dismiss this.
On the other hand, I’ll tend to dismiss it as being less important because (a) wages follow prices, not the other way around, and (b) we already knew that wages were rising because the Atlanta Fed Wage Tracker, which controls for composition effects, is +3.3% over the last year and will probably bump higher again this month. But the rise in private wages to a 9-year high is just one more dovish argument biting the dust.
Continue reading Potpourri for $500, Alex
By Anthony B. Sanders
…As Sears Closes Another 72 Stores
The inflation numbers are out for April and the numbers show that the Core Personal Consumption Expenditure Deflator remained the same as March at 2.0% YoY. Although increasing, “inflation” remains tepid since The Great Recession ended (mostly under the 2% Fed inflation target).
While inflation remains tepid, things are anything but “business as usual” at Sears. Sears’ stock price never quite recovered from The Great Recession and, like many big box retailers, has been “Bezos’d”.
Continue reading Inflation? Core PCE Deflator YoY Hits 2.0% For April…
By Michael Ashton
Below is a summary of my post-CPI tweets.
- OK, 20 minutes to CPI. Let’s get started.
- Although chatter isn’t part of the CPI, it’s interesting to me as a CPI guy. The chatter seems less this month than last month (maybe because of two readings <0.2%). I guess no easy ‘cell phone story’ to latch onto.
- Last month there was of course that talk about cell phones, and the jump in core did excite breakevens…a little. 10y breaks now at 2.18%, highest in 4 years. But, as I recently pointed out, You Haven’t Missed It.
- Consensus expectations this month are for 0.19 on core or a little softer. Y/Y will rise to 2.2% if core m/m is 0.13 or above. Outlier of 0.23 would move us to 2.3% and be a surprise to many.
- Average over last 6 months is 2.56% rate. I saw a funny article saying ‘but that’s due to cell phones.’ Of course, the m/m rate is not due to cell phones dropping off from March of last year. Median CPI is at 2.48%. So this is not the new normal. It’s the old normal.
- No one is much more bullish than expecting an 0.2% every month…that’s a 2.4% annually; most economists see that as something close to the high of sustainable inflation. But again, that’s the old normal. It just seems new because it has been a LONG time since we’ve been higher.
- They’re wrong on that! Just not sure how soon this all comes through.
- So last month, in addition to the bump in core services y/y (because of cell phones), core goods also moved to -0.3% from -0.5% and -0.7% the prior mo. The lagged weakness in the dollar, along with the rise in goods prices caused by trucker shortages, should be showing up here.
- Lodging Away from Home took a big y/y jump last month, but it’s a volatile category with a small weight. It’s usually an excuse to people who expected something different on the month.
- I continue to watch medical care, which is important in core services. Doctor’s services still showing y/y inflation as of last report, but both Doctors Services and Hospital Services rose last mo.
- 15 minutes until the number!
- Buying in the interbank market for the monthly reset (for headline) is 250.68.
- Very weak number. 0.10% on core CPI. y/y ticks up only slightly, to 2.12% from 2.11%.
- Last 12. Surprising. Note that last April was 0.09% so might be some seasonal issue with April. Sometimes Easter plays havoc, and Easter was early. But that’s usually more a Europe thing.
- Massive drop in CPI for Used Cars and Trucks. -1.59% m/m, taking y/y to -0.9 from +0.4. That’s odd – very different from what the surveys are saying.
- The Mannheim Survey actually ticked UP this month.
Continue reading Post-CPI Summary
By Michael Ashton
I try to stay away from making predictions. I don’t see the upside. If I am right, then yay! But after the fact, predictions often look obvious (hindsight bias) and it is hard to get much credit for them. By the same token, if I am wrong then the ex post facto viewer shakes his head sadly at my obtuseness. Sure, I can make a prediction with a very high likelihood of being true – I predict that the team name of the 2019 Super Bowl winner will end in ‘s’ – but there’s no point in that. This is one of the reasons I think analysts should in general shy away from making correct predictions and instead focus on asking the correct questions.
But on occasion, I feel chippy and want to make predictions. So now I am going to make a ridiculously specific prediction. This prediction is certain to be incorrect; therefore, I just want to observe that it would be churlish of you to criticize me for its inaccuracy either before or after the fact.
Ten-year Treasury rates will break through 3% for good on May 10, and proceed over the next six weeks to 3.53%. As of this Thursday, year/year core CPI inflation is going to be 2.2% or 2.3%, and median CPI over 2.5% and nearing 9-year highs. At that level of current inflation, 3% nominal yields simply make no sense, especially with the economy – for now – growing above trend. Two percent growth with 2.5% inflation is 4.5%, isn’t it? There is also no reason for 10-year real yields to be below 1%, so when we get to that 3.53% target it will be 1.08% real and 2.45% expected inflation (breakevens).
Continue reading My Ridiculously Specific Expectation for 10-year Interest Rates
By Michael Ashton
On Monday I was on the TD Ameritrade Network with OJ Renick to talk about the recent inflation data (you can see the clip here), money velocity, the ‘oh darn’ inflation strike, etcetera. But Oliver, as is his wont, asked me a question that I realized I hadn’t previously addressed before in this blog, and that was about inflation pressure on corporate profit margins.
On the program I said, as I have before in this space, that inflation has a strong tendency to compress the price multiples attached to profits (the P/E), so that even if margins are sustained in inflationary times it doesn’t mean equity prices will be. As an owner of a private business who expects to make most of the return via dividends, you care mostly about margins; as an owner of a share of stock you also care about the price other people will pay for that share. And the evidence is fairly unambiguous that inflation inside of a 1%-3% range (approximately) tends to produce the highest multiples – implying of course that, outside of that range, multiples are lower and therefore stock prices tend to adjust when the economy moves to a new inflation regime.
But is inflation good or bad for margins? The answer is much more complex than you would think. Higher inflation might be good for margins, since wage inputs are sticky and therefore producers of consumer goods can likely raise prices for their products before their input prices rise. On the other hand, higher inflation might be bad for margins if a highly-competitive product market keeps sellers from adjusting consumer prices to fully keep up with inflation in commodities inputs.
Of course, business are very heterogeneous. For some businesses, inflation is good; for some, inflation is bad. (I find that few businesses really know all of the ways they might benefit or be hurt by inflation, since it has been so long since they had to worry about inflation high enough to affect financial ratios on the balance sheet and income statement, for example). But as a first pass:
|You may be exposed to inflation if…
||You may benefit from inflation if…
|You have large OPEB liabilities
||You own significant intellectual property
|You have a current (open) pension plan with employees still earning benefits,
||You own significant amounts of real estate
|…especially if the workforce is large relative to the retiree population, and young
||You possess large ‘in the ground’ commodity reserves, especially precious or industrial metals
|…especially if there is a COLA among plan benefits
||You own long-dated fixed-price concessions
|…especially if the pension fund assets are primarily invested in nominal investments such as stocks and bonds
||You have a unionized workforce that operates under collectively-bargained fixed-price contracts with a certain term
|You have fixed-price contracts with suppliers that have shorter terms than your fixed-price contracts with customers.
|You have significant “nominal” balance sheet assets, like cash or long-term receivables
|You have large liability reserves, e.g. for product liability
Continue reading Inflation and Corporate Margins
By Michael Ashton
A question I always enjoy hearing in the context of markets is, “Have I missed it?” That simple question betrays everything about the questioner’s assumptions and about the balance of fear and greed. It is a question which, normally, can be answered “no” almost without any thought to the situation, if the questioner is a ‘normal’ investor (that is, not a natural contrarian, of which there are few).
That is because if you are asking the question, it means you are far more concerned with missing the bus than you are concerned about the bus missing you.
It usually means you are chasing returns and are not terribly concerned about the risks; that, in turn – keeping in mind our assumption that you are not naturally contrary to the market’s animal spirits, so we can reasonably aggregate your impulses – means that the market move or correction is probably underappreciated and you are likely to have more “chances” before the greed/fear balance is restored.
Lately I have heard this question arise in two contexts. The first was related to the stock market “correction,” and on at least two separate occasions (you can probably find them on the chart) I have heard folks alarmed that they missed getting in on the correction. It’s possible, but if you’re worried about it…probably not. The volume on the bounces has diminished as the market moves away from the low points, which suggests that people concerned about missing the “bottom” are getting in but rather quickly are assuming they’ve “missed it.” I’d expect to see more volume, and another wave of concern, if stocks exceed the recent consolidation highs; otherwise, I expect we will chop around until earnings season is over and then, without a further bullish catalyst, the market will proceed to give people another opportunity to “buy the dip.”
Continue reading You Haven’t Missed It
By Steve Saville
In February of this year the year-over-year rate of growth in the US True Money Supply, a.k.a. the US monetary inflation rate, was only 2.4%. This was its lowest level since March of 2007 and not far from a multi-decade low. In March of this year, however, the monetary inflation rate almost doubled — to around 4.6%. Refer to the following chart for more detail. What caused the reversal and what effect will it have on the economy and the financial markets?
The Fed has been slowly removing money from the economy via its QT program, so March’s money-supply surge wasn’t caused by the central bank. The main cause also wasn’t the commercial banking industry, because although there has been an up-tick in the rate of bank credit expansion over the past month it is nowhere near enough to explain the increase in TMS.
Continue reading A Dramatic Upward Reversal in US Monetary Inflation