Financial Conditions Make A Monetary Roundtrip and Undercut the Need for Rate Cuts
Posted: March 18, 2024 Filed under: Bond market, Central bank, commodities, CPI, Economy, gold, Jobs, Monetary Policy, oil, PPI, Stock Market | Tags: copper, CPI, Economy, FCX, Federal Reserve, finance, Freeport McMoRan, GDP, gld, gold, initial claims, interest rates, iShares 20+ Year Treasury Bond ETF, Jerome Powell, lumber, National Financial Conditions Index, NFCI, oil, PPI, S&P 500, SPDR Gold Shares, SPY, TLT, unemployment, United States Oil Fund 2 CommentsLast week, financial markets stared in dismay at “sticky” inflation numbers on the consumer and wholesale side. Both the CPI (consumer price index) and wholesale inflation (the producer price index or PPI) printed slightly higher than “expected” (headline and core) and added to the sense that inflation may have gone from fizzle to sizzle. While overall momentum still favors an eventual confirmation for those who declared inflation dead last year, a more important reality looms to undercut the need for the Federal Reserve to cut interest rates. Financial conditions are just as loose as they were in the months leading up to the launch of the Fed’s aggressive campaign to tighten monetary policy (launched in March, 2022). This monetary roundtrip is evident in the Federal Reserve Board of Chicago’s National Financial Conditions Index (NFCI) (follow the black line for ANFCI):
I am tempted to say financial markets have already done the Fed’s work. However, it is very likely that the minute the Federal Reserve even hints that rate cuts could be delayed until next year, the resulting tantrum in financial markets could be epic. The Fed is loathe to disappoint markets, and the message from the last meeting and subsequently from Jerome Powell has been to promise a rate cut sooner than later. Financial markets have persistently focused on any and all dovish twinges in Fed-related pronouncements. For example, from Powell’s testimony to Congress on March 6th (emphasis mine):
“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
Powell can insert all the standard caveats he wants. Markets read this statement as saying rate cuts are on their way!
A Nervous Bond Market
Yet, bond markets have been a little “nervous” all year. For example, the iShares 20+ Year Treasury Bond ETF (TLT) has trended downward (meaning higher bond yields) so far this year with lower highs and lower lows. From TradingView:
TLT is just a fresh low of the year away from finally catching the stock market’s attention again.
Copper, Lumber, and Oil – oh my!
The bond market has good reason for some jitters. Several commodities have sprung back to life this year. Copper miner Freeport-McMoRan Inc (FCX) is welcoming the upcoming Fed meeting with a 7+ month high. FCX is up 19.8% in less than two weeks. (FCX has been stuck in a trading range since the beginning of 2021).
Lumber bottomed out in early 2023. This month, lumber broke out above last summer’s high and is back to levels last seen in August, 2022.
Oil, everyone’s favorite non-core component of inflation, has been in “stealth” rally mode all year. The United States Oil Fund, LP (USO) looks ready to launch parabolically on the wings of rate cuts.
Where will these prices go with rate cuts? I vote higher.
The Golden Touch
Speaking of getting ready for rate cuts, gold, my favorite hedge enjoyed a spectacular (and overdue) breakout this month. SPDR Gold Shares (GLD) traded at an all-time high at its peak this month.
I like buying the dips in GLD going forward. The odds seem sufficiently high for the Fed to feel “forced” into easing into a sea of market liquidity.
Straining to See the Weakness in Labor Markets
So maybe the Fed can strain its economic gaze and find an excuse to do a “proactive” rate cut. The graph below shows the unemployment rate has likely bottomed out (left axis and blue line) Yet, it remains near historic lows. Initial unemployment claims have been trendless with a recent peak set last summer (right axis and green line). Finally, real GDP quarter-over-quarter growth has levitated in positive territory and for the last two years has defied overly persistent expectations for a recession (right axis and red line). From my perch, I see no excuse for a rate cut here, but perhaps I am not creative enough with the data.
Sources: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis.
The Stock Market’s Giddy Anticipation
The stock market’s giddy anticipation of rate cuts is poetic. The stock market has soared on loosening financial conditions and has been able to ignore just about any bad news the macro environment tries to toss out there. Recent successive all-time highs speak volumes to the buffer the Fed can enjoy if it so chooses to wait out the Presidential election before making changes to monetary policy.
Conclusion
With market breadth increasingly lagging the stock market’s ascension, I have been a skeptic about the overall rally for several weeks. The Federal Reserve is probably the last catalyst between now and the Presidential election that has a chance of validating my skepticism. If the Fed complies with the market’s giddiness, there is no telling how high the market could soar in coming months. If the Fed decides to wait things out, the stock market will lose a major contributor to the upward and higher fund. Then again, maybe the Fed pulls off a magical “hawkish rate cut” (one and done rate cut with a warning about the potential for inflation to rise from the ashes). The Fed could figure out just the right balance between disappointing the stock market and fueling ever increasing levels of speculation and higher commodity prices…
Be careful out there!
Full disclosure: long GLD
From Inflation Fizzle to Sizzle
Posted: February 13, 2024 Filed under: Bond market, CPI, Currencies, Housing, Monetary Policy | Tags: Canadian dollar, CME FedWatch Tool, Consumer Price Index, CPI, DXY, Economy, EUR/USD, Federal Reserve, finance, FXC, FXE, inflation, Invesco CurrencyShares Canadian Dollar Trust, Invesco CurrencyShares Euro Currency Trust, iShares 20+ Year Treasury Bond ETF, Monetary Policy, NAHB, National Association of Home Builders, rate probabilities, services inflation, shelter inflation, TLT, U.S Dollar, U.S. Bureau of Labor Statistics, USD/CAD, VIX, volatility index 1 CommentInflation is probably still dead, but its “stickiness” still has the potential to spook financial markets. In the middle of a giddy dance on inflation’s grave celebrating an inflation fizzle, the January, 2024 CPI (consumer price index) report delivered sizzle with a hotter than consensus expectations and sent the bond and stock market into a swirl. The following table comes from a CNBC interview with National Economic Director and former Federal Reserve vice chair Lael Brainard:
Nevermind that a read hotter than consensus has little impact on the current trend. The chart below from the U.S. Bureau of Labor Statistics shows that even as core CPI (all items less food and energy) is flattening out a bit (the red line), the “sticky” shelter component of inflation is still hurtling downward (the purple line).
With the trend still favoring the death of inflation, I think of “sticky” as a reference to people’s impatience with an inflation component taking too long to converge with the overall average inflation level. The CPI report highlighted the relative stubbornness of shelter inflation:
“The shelter index increased 0.6 percent in January, and was the largest factor in the monthly increase in the index for all items less food and energy. The index for owners’ equivalent rent rose 0.6 percent over the month, while the index for rent increased 0.4 percent. The lodging away from home index increased 1.8 percent in January…The shelter index increased 6.0 percent over the last year, accounting for over two thirds of the total 12-month increase in the all items less food and energy index.”
The bubble chart below from the U.S. Bureau of Labor Statistics shows the outsized influence of services less energy services on total inflation (the large purple bubble). This major component includes shelter. Its relative importance of 60.9 dwarfs the relative importance of all other major components of inflation.
Given the angst directed at the shelter component of inflation, I looked at what the National Association of Home Builders (NAHB) had to say about this CPI report. The industry group provided a reassuring conclusion: “the NAHB forecast expects to see shelter costs decline further in the coming months. This is supported by real-time data from private data providers that indicate a cooling in rent growth.” So while the housing price picture is mixed with existing homes on the uptick and new homes on the downtick, overall rents should continue a cooling pace as expected.
Unfortunately for those traders and investors buying stocks and bonds in anticipation of rate cuts, this reminder of inflation’s stickiness pushed out expectations for the first rate cut from the Federal Reserve. Over-eager financial markets pushed out the first rate cut from May to June. This is a bitter pill to swallow for those who started buying stocks and bonds late last year in anticipation of a rate cut in March (because the Fed admitted to inflation’s death of course). The chart from the CME FedWatch Tool shows how the odds favoring a May rate cut immediately evaporated.
The Fizzle and Sizzle in Financial Markets
Interestingly, currency markets and the bond market have been moving counter to the rallies in the S&P 500 (SPY) and the NASDAQ (COMPX). The 2024 rally in the U.S. dollar index (DXY) has taken the index ABOVE the point where currency traders dumped the dollar in the wake of inflation’s death. The chart below from Tradingview.com shows a bullish breakout for the dollar last month above its 50-day moving average (DMA) (the red line) and a successful test of the trend line as support earlier this month.
The dollar’s rally complicates my bullish trades on the Canadian dollar but also provides my latest opportunity to fade USD/CAD (Invesco CurrencyShares Canadian Dollar Trust (FXC)) within the trading range. I am net long the U.S. dollar by being short EUR/USD (Invesco CurrencyShares Euro Currency Trust (FXE)).
Excluding a sharp countertrend rally at the end of January, iShares 20+ Year Treasury Bond ETF (TLT) has sold off most of 2024.
These trends further reinforce the notion and fear that perhaps earlier rate cut expectations were indeed premature. After the market’s pullback (the S&P 500 lost 1.4% and remains in an uptrend) will stocks also concede the point or will they return to ignoring deteriorating market breadth and other signs of caution in the stock market?
The volatility index (VIX) may have already blown off enough steam to soothe the groans of the bulls…for now. Note carefully how the VIX stopped going down this year and thus has an ever so slight uptrend going…
Be careful out there!
Full disclosure: net long U.S. dollar
Bank of Canada’s Macklem: The End is In Sight But Rates Are Not Returning to Pre-Pandemic Levels
Posted: January 7, 2024 Filed under: Canada, Economy, Monetary Policy | Tags: Bank of Canada, Canadian dollar, economics, Economy, FXC, interest rate, interest rates, Invesco CurrencyShares Canadian Dollar Trust, Monetary Policy, soft landing, Tiff Macklem, USD/CAD 1 CommentIn a BNN Bloomberg video interview late last month, the Bank of Canada’s governor Tiff Macklem essentially laid out the gameplan for Canada’s monetary policy in 2024. Macklem reassured Canadians that the end of inflationary pressures and tight monetary policy is “in sight.” However, he also prepared Canadians to expect a new regime of higher interest rates than was the norm before the pandemic: “I think it is reasonable to expect that they’ll come down, but they probably won’t come down to pre-crisis levels. We had 10-12 years of unusually low interest rates post Global Financial Crisis. I think there are good reasons to believe that we’re not going back to those very low rates.”
This admonition is unsurprising given Macklem’s general reluctance to declare victory over inflation. While the Bank of Canada increasingly sees the elements needed to get inflation back down to 2%, Macklem stated that “we are not there yet.” They need to see sustained and further (for “a number of months”) downward momentum in core inflation.
Cautious About the Signs of Victory Over Inflation
December’s statement on monetary policy also reflected the Bank of Canada’s wavering. The statement estimated that “data and indicators for the fourth quarter suggest the economy is no longer in excess demand. The slowdown in the economy is reducing inflationary pressures in a broadening range of goods and services prices.” These conditions should have generated a declarative victory statement. Instead, the Bank of Canada proceeded to posture staunchly against inflation: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed. Governing Council wants to see further and sustained easing in core inflation, and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”
Still, in the interview, Macklem acknowledged that rates are likely to start coming down in 2024. He just refused to provide a timetable.
The Soft Landing
The interviewer pointed out that the scenario Macklem portrays sounds like a “soft landing” for the economy. Macklem was careful not to use that term. Instead he pointed out that much of the adjustment in the labor market has come through a reduction in vacancies instead of a large rise in unemployment. An anticipated weakness in growth for the next 2 to 3 quarters should not generate a “deep” recession. Macklem directly claimed that “we can get inflation back to 2% without a recession.”
This year will be a transition year. By the end of the year, the economy should be in soft landing mode if all goes well.
The Canadian Dollar
The Bank of Canada released its December statement on monetary policy just as the U.S. dollar was experiencing a slight relief rally against the Canadian dollar (USD/CAD) (or the Invesco CurrencyShares Canadian Dollar Trust (FXC)). The slide resumed with the Federal Reserve’s decision on monetary policy the following week and the resulting celebration over the implicit announcement that inflation in the U.S. is dead. I had long anticipated the decline at the time with a target of testing the lower part of a trading range in place since September, 2022.
After taking profits, I am back to accumulating a short position. I expect the Bank of Canada’s on-going caution and the Bank’s refusal to get dovish to act as a tailwind for the Canadian dollar. The chart below from TradingView.com shows volatility in USD/CAD distinctly driven by key events. The Bank of Canada’s next Monetary Policy Report will come on January 24th. The Fed comes around the week after.
So, overall, I continue to favor playing the trading range in USD/CAD as an eventual trip to or toward the bottom of the range. I currently cannot foresee catalysts that will push the currency pair to stray too far away from the range. If USD/CAD escapes the range, I think the odds favor a breakdown over a breakout.
Be careful out there!
Full disclosure: short USD/CAD
Inflation Now, Inflation 76 Years Ago
Posted: January 7, 2024 Filed under: CPI, Economy, Europe, Housing, Industrial, Monetary Policy | Tags: CPI, employment, geopolitics, GI Bill, industrial policy, labor strike, labor unrest, NY Times, voter opinion, wages, World War 2, World War II Leave a commentIn “Want to Understand 2024? Look at 1948“, the New York Times drew some fascinating parallels between today’s economic and political climate and the era leading to Harry Truman’s surprise victory over Thomas Dewey in the 1948 Presidential election. One key quote summarized the context: “in the era of modern economic data, Harry Truman was the only president besides Joe Biden to oversee an economy with inflation more than 7% while unemployment stayed under 4% and GDP growth kept climbing.” I took particular interest in the references to the inflationary dynamics from around 76 years ago.
Inflation landed around 20% in 1947 according to the NY Times who also claimed it was the worst inflation America experienced over the past 100 years. The article did not specify the inflation measure, so for the purposes of discussion I assume the article referred to the entire Consumer Price Index (CPI). If so, then the 20% figure must have been for a particular month in 1947. The annual inflation for 1947 was 8.8% according to Investopedia, far short of the highest level over the past 100 years. Inflation the year before soared to 18.1% from 1945’s 2.2%. While it looks like the NYT selectively picked an inflation number for effect, it is clear that sentiment on inflation during this time was as dour as one should expect during a period of exceptionally high inflation. The following bullets are mostly direct quotes from the article reordered chronologically:
- In December 1947, more than 70% of adults said they would want their own wages to decline in order to bring prices down.
- In polling throughout 1947 and 1948, a majority supported reinstating wartime rationing and price controls.
- Before the conventions, voters said a plan to address high prices was the No. 1 priority they wanted in a party platform. More voters said they wanted prices to be addressed over the next four years than any other issue.
- In June, 1948, a majority of voters expected prices would be higher in six months (at election time in November, only 18% of voters expected the same).
- As late as summer 1948…adults expected prices to keep rising.
A combination of economic pressures sent inflation soaring.
Post-war supply shortages combined with the end of price controls to light a fire under inflation. The NY Times article pointed out that labor unrest following World War 2 exacerbated supply shortages. For example, the National WWII Museum in New Orleans observes: “With the end of the wartime no-strike pledge, workers across America expressed their frustration with wages and working conditions through a series of strikes that involved over 5 million people from the end of 1945 and into 1946.” Strikes hit broad swaths of the economy: mills, telephone service, meat packing, and General Electric (a major industrial employer at the time). The railroad strike of 1946 crippled large parts of the economy (the interstate highway system did not start until Eisenhower’s presidency in the 1950s). No doubt all this economic disruption helped dampen the national mood alongside the resulting price pressures.
Layer on pent-up consumer demand and the economy got hit with a perfect inflationary storm. Benefits from the GI Bill, not mentioned in the NY Times article, helped to stoke consumer demand. For example, while the country built very little housing during World War II, the GI Bill offered returning soldiers low interest, zero down payment home loans with better terms for newly built housing. Although Black servicemen were often denied benefits of the GI Bill (and thus they were often left in poverty), such incentives must have contributed to increased pricing pressures in the economy.
The NY Times article also did not consider the potential price distortion from large amounts of U.S. resources funneled into the Marshall Plan. The Marshall Plan kicked off in 1948, and it is plausible suppliers felt emboldened to increase prices in anticipation of the largess. Supply responses in Europe would eventually erode this pricing power.
Fast forward to today and we find parallel economic distortions putting pressure on prices. Massive fiscal and monetary stimulus stoked demand, especially for housing and related goods. Government supported pandemic savings have apparently supported on-going strength in retail spending. Wage growth has also supported robust consumer demand. While today’s labor unrest pales in comparison to post-war labor actions, the scales have tipped in favor of labor for now. Unemployment remains at historic lows, and employers have readily absorbed the rebound in the labor force participation rate. U.S. industrial policy could apply its own upward pressures on prices in the economy.
The Federal Reserve on the Sidelines of Late 1940s Inflation
The volatile cocktail of inflationary pressures must have complicated monetary policy. Compared to today’s tornadic monetary policy response, the Fed’s rate hikes in the immediate post-war years look exceptionally timid. The Federal Reserve essentially sat on the sidelines as the economy convulsed through its inflationary pressures. From “A New Daily Federal Funds Rate Series and History of the Federal Funds Market, 1928-1954“:
Today’s deflationists would have been particularly happy with the timid Fed of the late 1940s and early 1950s! Fresh memories of the economic devastation of the Depression no doubt also slowed the hand of the Fed. The NY Times article did not delve into the role of the Fed in allowing inflation to take its course in the post war years.
Inflation Today
Pandemic disruptions are mostly in repair, but Russia’s invasion of Ukraine has caused its own supply disruptions. The Israel-Hamas war threatens to cause disruptions in global oil markets and shipping lanes in the Gulf. Growing tensions between China and Taiwan and increasing authoritarian control over the Chinese economy have motivated companies to leave China in search of “safer” countries for production. This transition will likely pressures prices through increased production costs and the short-term transition costs.
In other words, while financial markets celebrate the end of the Federal Reserve’s fight against inflation, there are plenty of looming inflation risks, any of which could deliver setbacks to current trends. Seventy-six years ago inflation came to a boil and then yielded through the 1950s and early 1960s. A parallel peak for today’s inflationary era would be welcome news!
A Memorial to Inflation…The Song and the Singer
Posted: January 2, 2024 Filed under: Entertainment | Tags: Earnest Jackson, music, obituary, Planet Money, recording industry, Sugar Daddy and the Gumbo Roux 2 CommentsOn December 13, 2023, I claimed that the Federal Reserve officially declared the death of inflation. I did not know it at the time but inflation had also just died in the world of entertainment. Earnest “The Voice” Jackson, Jr. passed away a week earlier on December 6th. Jackson came to public fame after NPR’s Planet Money discovered his 1975 song “Inflation”. Some unnamed person sent Planet Money the song on a cassette tape. They naturally loved the song and decided to release it as part of a 3-part series and economics lesson that demonstrated what it takes to make a hit in the music industry. That mystery tape changed Jackson’s life just in time.
Planet Money released the song in November, 2022 under their newly formed Planet Money Records label. They had to track down all the members of the band who performed the song, Sugar Daddy and the Gumbo Roux (including Randy Jackson of American Idol fame!), and convince them to agree to terms. Planet Money even promoted the song and as of December, 2023 achieved over 2 million streams. I was one of many fans who streamed the song often and regularly to help the cause.
It is ironic Jackson died just as economic inflation (apparently) died. It is doubly ironic that Jackson passed away so soon after he finally realized his lifelong dream to get signed and hear his own song on the radio. I never got around to figuring out how to make “Inflation” a theme song for this site. Instead, I have written this small acknowledgement and memorial to Jackson for giving so many “Inflation” as a form of edutainment. I also extend a HUGE thank you to Planet Money for making the adventure happen, especially given it was a money-losing enterprise for them. The person who sent that tape must have known something…!
Earnest Jackson, Jr. died at the age of 75.
{Note: On January 2, 2024, I submitted a Wikipedia entry for Earnest Jackson. I hope to get it approved for publishing within the next month or so. It will be my first ever Wikipedia entry.}
The Federal Reserve Makes It Official: Inflation Is Dead
Posted: December 13, 2023 Filed under: Economy, Monetary Policy | Tags: DXY, Economy, Fed Fund Futures, Federal Reserve, inflation, interest rates, Jerome Powell, Monetary Policy, U.S. dollar 8 CommentsAt the risk of making Inflation Watch a lot less relevant and topical, I am pointing out that today’s meeting of the Federal Reserve essentially spoke of a victory over inflation. The threat of inflation has been vanquished; inflation is dead. In place of hawkishness and monetary tightening now comes “consideration of a time for cutting rates.” Fed Chair Powell wrestled with this concept throughout the press conference.
The key trigger word was “any.” The first question from the press zoomed directly on the insertion of “any” in the following section of the Fed’s policy statement (emphasis mine):
“In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
Powell’s response essentially confirmed that the Fed thinks it is done fighting inflation with rate hikes. The Fed is so confident that it is now considering how to conduct a rate easing cycle.
“We added the word ‘any’ as an acknowledgement that we believe that we are likely at or near the peak rate for this cycle. Participants didn’t write down additional hikes that we believe are likely…but participants didn’t want to take the possibility of further hikes off the table.”
The last part about keeping rate hikes on the table is just obligatory caution that in name keeps the Fed’s options open just in case.
The next question came from Governor Chris Waller’s claim that the Fed could be cutting rates in the next several months if inflation continued to fall. Powell of course did not respond directly to the commentary, but he affirmed that the Fed has its mind on rate cuts for 2024:
“…the other question of when will it become appropriate to begin dialing back the amount of policy restraint in place that begins to come into view and is clearly a topic of discussion out in the world and and also a discussion for us at our meeting today.”
Note Powell conditioned his remarks to say that “no one is declaring victory, that would be premature.” But again, this is obligatory caution. Victory is practically oozing out of every pore of this meeting. The Fed has to take small and methodical steps in its march to victory.
Inflation Is Dead
Powell’s most revealing answer came to a question about what motivates the Fed to consider rate cuts:
“Both headline and core [inflation] have come down really significantly in three months, that’s a big piece of this. At the same time growth has turned out to be very strong in the third quarter is slowing we believe as appropriate, and we’ve got we’ve had several labor market reports which suggest again significant progress toward greater balance across a very a broad range of indicators. You’re seeing so many of the indicators come back to normal.”
Importantly, Powell noted later in the Q&A that the Fed has seen progress in the most worrisome component of the inflation basket: non-housing services. Now, all three components of core inflation are contributing to inflation’s demise.
Powell further stated that a rate hike is no longer the base case unlike 60 or 90 days ago. He pointed to individual board members who have assessments about the timing for reducing tight policy when saying “that is a discussion we’ll be having going forward.”
Notably, while Powell insisted the job remains to get inflation down to 2%, he acknowledged in response to a reminder about statements in July that the Fed cannot wait until 2% inflation to start cutting rates:
“The reason you wouldn’t wait to get the 2% to cut rates is that policy would be it would be too late. You’d want to be reducing restriction on the economy well before 2% so you don’t overshoot…you know it takes a while for policy to get into the economy and affect inflation.”
Financial Markets Are Ready for Rate Cuts Sooner Than Later
At one point recently, financial markets pessimistically rolled back the first rate cut to September, 2024. Going into this meeting, the market planted the flag on a March rate cut but retreated the day before in the wake of November CPI data. At the time of writing, the first rate cut is firmly rooted in March (source: CME FedWatch) – follow the blue colored boxes for the most likely scenario for a given interest rate policy (labeled across the top of the chart) and a given meeting date (labelled across the left side of the chart).
The comparison chart below shows how the odds for a March rate cut were 39.7% yesterday but 54% a week ago. A month ago the odds were a mere 10.5%. Market opinion has changed rapidly!
Conclusion
In the end, Inflation Watch will stay on the case. The situation remains uncertain and the citizenry are still not happy about prices. Powell admitted as much:
“The price level is not coming down…so people are still living with high prices and that’s something people don’t like. Real wages are now positive so that wages are now moving up more than inflation. As inflation comes down that might help improve the mood of people.”
So while the Fed keeps working, and wages keep trying to outpace inflation, Inflation Watch will keep on watching and reporting!
In the meantime, see below the dramatic impact of the Fed’s declaration of victory on the U.S. dollar (DXY); the recent downtrend looks ready to resume (source: TradingVIew.com).
Full disclosure: long and short U.S. currency pairs
Despite the Inflation Celebrations, the Case Against Team Transitory Still Stands
Posted: November 15, 2023 Filed under: Automobiles, Banks, Economy, Housing, Monetary Policy | Tags: auto loans, automobiles, CPI, Federal Reserve, FICO, housing market, inflation expectations, interest rates, Joseph Stiglitz, Monetary Policy, PCE, Personal Consumption Expenditures Leave a commentThe excitement over a slightly softer than “expected” October inflation print extended from financial markets – where stocks soared, the U.S. dollar plunged, and bond prices soared – to economists celebrating predictions that inflation would one day come down from lofty levels…no matter what the Fed did. In a piece published before the October CPI report, economist Joseph Stiglitz triumphantly wrote a piece titled “Turns out that inflation really was transitory, no thanks to the Fed.” Stiglitz effectively claimed that the Federal Reserve should have stuck with its transitory narrative on inflation in the immediate wake of the pandemic. This claim runs directly counter to those of us who believe the Fed rested on its transitory laurels too long and moved too slowly to start normalizing interest rates. I specifically take issue with Stiglitz’s omission of important context surrounding the Fed’s belated decision to start hiking rates:
- The Federal Reserve had driven monetary policy to historic heights of accommodation: a 9 trillion dollar balance sheet combined with a return to zero interest rates: an easy money paradigm that itself needed to be transitory.
- The Federal Reserve instituted a risk management framework that targeted tail risks instead of an “expected” path of inflation and its resulting impact on the economy.
Moreover, Stiglitz offered two examples from the economy, autos and shelter, that do not conclusively demonstrate the Fed had no impact on inflation. Even Stiglitz’s discourse on inflation expectations is open to varying interpretations. I will tackle each of these issues one-by-one starting with auto inflation.
Auto Inflation: A Counterfactual
Stiglitz makes a big deal out of the obvious fact that the Fed could not solve chip supply problems in the auto industry by hiking interest rates. While the Fed never staked a claim to such powers, and even acknowledge its lack of such powers, this complaint is common among Fed critics who apparently wanted the Fed to leave monetary policy accommodative and lower for longer. Stiglitz pulls the rug from under the Fed by insisting “Given that its interest-rate hikes did not help resolve the chip shortages, it cannot take any credit for the disinflation in car prices.”
So now with auto prices inevitably lower, critics like Stiglitz are declaring victory on the prediction that car prices would eventually come down. Fine. How about a counterfactual? If the Fed had left rates lower for longer is it credible to believe that the path for prices would have stayed exactly the same (or improve)? I claim the answer is no. Assuming lower loan rates encourage and incentivize more borrowing (indeed this is a fundamental premise for accommodative monetary policy), then rock bottom rates would have fueled on-going and even increasing demand for cars and deepened pressures against short supply. In other words, I am claiming auto inflation would have been even worse and could have caused other cascading problems in the economy.
Even throwing away abstract counterfactual arguments, the actual data is not conclusive enough to suggest the Fed had zero (or even little) impact. The chart below juxtaposes new and used car prices with the auto inventory/sales ratio (cars and light trucks). This ratio puts demand and supply into context. While the the ratio bottomed out in late 2021, it is still nowhere close to pre-pandemic levels. Deflation/disinflation should not be this dramatic with the inventory/sales ratio still at historically low levels. I would have expected a price plunge to accompany a much faster recovery in the inventory/sales ratio. In fact, I would have expected the pendulum to at least swing above 1 again.
Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Used Cars and Trucks in U.S. City Average [CUSR0000SETA02], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: New Vehicles in U.S. City Average [CUUR0000SETA01], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Economic Analysis, Auto Inventory/Sales Ratio [AISRSA], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.
In other words, while supply has been slowly normalizing, demand still outstrips supply. This is a condition for higher prices. Yet, resurgent inflation in autos is not likely specifically because high interest rates are constraining and reducing the ability and willingness to pay higher and higher prices. The rate on the 48-month auto loan was last this high in 2002.
Source: Board of Governors of the Federal Reserve System (US), Finance Rate on Consumer Installment Loans at Commercial Banks, New Autos 48 Month Loan [TERMCBAUTO48NS], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.
Finally, domestic banks have also tightened lending standards, likely further constraining the ability to pay higher prices. Lending standards tighten with tighter monetary policy as banks become more risk averse and have a higher cost of funds. This is a Fed effect. From the October, 2023 “Senior Loan Officer Opinion Survey on Bank Lending Practices“:
“In a set of special questions, banks were asked to assess the likelihood of approving credit card and auto loan applications by borrower FICO score (or equivalent) in comparison with the beginning of the year. Significant net shares of banks reported that they were less likely to approve both credit card and auto loan applications from borrowers with FICO scores of 620. Moderate and significant net shares of banks reported that they were less likely to approve credit card loan applications and auto loan applications, respectively, from borrowers with FICO scores of 680. In contrast, a modest net share of banks reported being more likely to approve credit card applications from borrowers with FICO scores of 720, while the likelihood of approving auto loan applications to borrowers with FICO scores of 720 was basically unchanged in comparison with the beginning of the year.”
Thus, I claim the Fed deserves at least partial credit for helping to tap the brakes on demand, in the form of ability to pay, in the face of relatively tight inventories. In other words, I find it compelling to create a narrative around a Fed impact that is at least as plausible as the narrative that completely discredits the Fed.
Shelter Inflation
The dynamics of shelter inflation are complex. I grant Stiglitz the point that higher interest rates can exacerbate inflationary pressures by reducing the availability of construction loans needed to increase supply. Interestingly, Stiglitz does not reference the complementary constrain t on supply from existing home owners who refuse to move and incur the cost of mortgages more expensive than their current ones.
Anyway, I will still point out that it was soaring shelter inflation that provided the signal to the Fed that rates were overly accommodative; the episode was a rare moment in Fed history where it acknowledge an inflationary problem from shelter costs. Historically low mortgage rates stoked demand and led to a mini-mania in the housing market. Prices soared practically uncontrollably for homes. Rent soared alongside home prices. I discussed the “housing trigger” for the Fed in “The Federal Reserve Fears On-Going Inflationary Pressures from Rents” and provided more detail in “Inflationary or A Bubble – Housing Prices Help Push A Fed Driving Recession-Pricing for Home Builders.”
I also provided evidence from a home builder about the impact of the Fed on cooling housing prices in “Lennar Corporation: How the Fed Is Cooling Inflation In the Housing Market.”
In other words, the mere fact that one-year leases on rents cause a lag in disinflation is insufficient to dismiss the various ways in which rent inflation forced the Fed to hike and to maintain its hiking campaign. A counterfactual on post-pandemic housing demand and prices in the face of prolonged accommodative policy should not be controversial: we have lived it three times in the span of just one generation.
Core Inflation
Stiglitz noted the following about headline inflation:
“The pandemic-induced inflation was exacerbated further by Russia’s invasion of Ukraine, which caused a spike in energy and food prices. But, again, it was clear that prices could not continue to rise at such a rate, and many of us predicted that there would be disinflation — or even deflation (a decline in prices) in the case of oil. We were right. Inflation has indeed fallen dramatically in the United States and Europe.”
This was a surprising sidebar when the Fed does not set monetary policy by what happens to food and energy. Adding to the distraction, Stiglitz does not label the inflation numbers her uses to compare to the Fed’s target. For the purposes of this discussion I will assume he is referring to core PCE (personal consumption expenditure, excluding food and energy) since it matches the number he uses for September. Yet, I cannot be 100% sure since the 3.7% change in the PCE in September matches the 3.7% headline change in the CPI (consumer price index) for September. This confusion is technically important because the median PCE sits at 4.4%. Core CPI was 4.1% in September, and the October report delivered the tiniest of cooling at 4.0%.
No matter the lens, these levels and incremental declines are hardly an occasion for final victory. While the Fed has every reason to stop hiking rates and watch what happens from here, these numbers do not tell me the Fed can pack up its toys and go home. Stiglitz takes care of that concern by calling the 2% inflation target arbitrary: “There is no evidence that countries with 2% inflation do better than those with 3% inflation; what matters is that inflation is under control. That is clearly the case today.” On the surface, the logic makes sense except that the period of “Great Moderation”, where deflation was the Fed’s biggest concern, was a period where PCE stayed below 2%. We do not have experience in THIS economy with a Fed that overtly allows inflation to stay well above 3%…and the Fed is clearly in no mood to push its luck.
Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.
Inflation Expectations
Stiglitz claims that the Fed also had nothing to do with controlling inflation expectations. Unlike the Fed, markets knew that inflation would naturally correct itself. Stiglitz even challenges the protest that inflation expectations remained calm specifically because of trust in the Fed: “…inflationary expectations remained tame. While some central-bank economists claim that this was due to their own forceful response, the data tell a different story. Inflation expectations were muted from early on, because markets understood that the supply-side disruptions were temporary.” Stiglitz took a debatable point and breathed unfounded certainty into it. Stiglitz focuses on the 5-year forward inflation expectation rate:
“Only after central bankers repeated over and over their fears that inflation and inflationary expectations were setting in, and that this would necessitate a long slog entailing high interest rates and unemployment, did inflationary expectations rise. (But, even then, they barely budged, reaching 2.67% for the average of the next five years in April 2021, before falling back to 2.3% a year later.)”
Yet, a different interpretation is plausible and valid regarding the stability in the 5-year forward expectation. It appears the market has a bias to expect disinflation (especially in response to shocks). Starting between 2015 and 2017, the market finally believed the Fed could hold inflation closer to 2.0%. This milestone came after persistent messaging, in different forms, from the Fed on the 2% target. It seems odd to blame the Fed for a brief spike in inflation expectations at the time the Fed started hiking rates. I find it more plausible to interpret the rapid return to previous levels as evidence the market was once again mollified over long-term prospects with a Fed clearly serious about constraining inflationary pressures.
Source: Federal Reserve Bank of St. Louis, 5-Year, 5-Year Forward Inflation Expectation Rate [T5YIFR], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.
Given it appears to take a lot to convince markets the Fed cannot control inflation over the “long-term”, I turned to shorter-term expectations as a more responsive indicator. It turns out that the 3-year consumer expectations peaked right as the Fed finally dropped the notion of transitory inflation in November, 2021. One-year expectations kept rising alongside inflation readings and peaked with a peak in inflation. Thus, it is very possible that the 3-year expectation more accurately reflects sensitivity to the Fed’s actions where it counts: consumers.
Source: Federal Reserve Bank of New York, Survey of Consumer Expectations
I go into more detail about the mechanics of inflation expectations in “Inflation Expectations and Inflationary Psychology.”
Since short-term expectations can start to bleed into longer-term expectations for inflation, the Fed took a risk management approach when it finally got serious about inflation. Tamp down short-term expectations and remove the risk of perturbing longer-term expectations which could prove harder to control above recent historical ranges.
The Risk Management Approach to Monetary Policy
The question is not whether or not the Federal Reserve should have acted to normalize monetary policy (by picking a non-zero target). The question is how far does/did the Fed need to go. Powell made it abundantly clear that the uncertain (and unprecedented) economic environment put the Fed in a risk management framework. The Fed decided it could not manage policy to the average or expected outcomes in the economy.
For example, a year ago, during the Q&A at a Brookings Institution conference, Powell claimed that monetary policy must take into consideration tail risks and their costs. The Fed collectively had decided that the costs of high inflation outweighed the potential risks of expeditiously hiking rates. The economy has proven so resilient that economists have spent over a year and half pushing out forecasts for a recession, a recession that could have been the main transmission mechanism for monetary policy to tank prices. Now, with the market celebrating the end of rate hikes and declaring victory over inflation, the runway is clear for the soft-landing narrative. I suppose those folks who think the Fed had no influence over inflation will have to conclude that monetary policy is totally meaningless if a recession is not forthcoming!
Conclusion
The inflation debate will never end because participants often bring to the table strong assumptions about the Fed’s capabilities and over-confidence in understanding the intricacies of the post-pandemic economy.
Ultimately, I stand by my long-standing claim that the Federal Reserve acted too slowly as supported by later economic research that I covered last June in “Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge.” I stake no claim on the ultimate target; I just claim that the Fed needed to start normalizing sooner given what could be known at the time about economic conditions and the massive monetary and fiscal stimulus in the economy. Stiglitz did not explicitly say that he would have preferred the Fed do nothing, but his stance implies as much and feeds the narratives that inflation was never a problem in the first place. Thus, the Fed cannot satisfy anyone, not the inflationistas like myself nor the disinflationistas like Stiglitz….and certainly not the deflationists who held sway for so long going into the pandemic.
Be careful out there!
Canada’s Version of Higher for Longer: Inflation Risks Have Increased
Posted: November 11, 2023 Filed under: Bond market, Canada, Currencies, Economy, oil | Tags: Bank of Canada, Canadian dollar, Federal Reserve, FXC, Invesco CurrencyShares Canadian Dollar Trust, Monetary Policy, Tiff Macklem, United States Oil Fund, USD/CAD, USO 1 CommentThe Bank of Canada (BoC) has completed a 180-degree turn from its goldilocks outlook on inflation from seven months ago. In its October Monetary Policy Report, the BoC lamented that “progress to the 2% [inflation] target is slow.” Governor Tiff Macklem’s opening statement for the accompanying press conference displayed a healthy amount of concern about inflationary pressures (emphasis mine): “further easing in inflation is likely to be slow, and inflationary risks have increased.”
The Bank of Canada is worried about higher energy prices, “structural pressures” in the housing market primarily related to supply shortages (which it acknowledged must first be addressed on the supply side), and “persistence in underlying inflation.” This underlying inflation consists of elevated “near-term inflation expectations and wage growth” and corporate pricing decisions that are “normalizing only slowly.” Core inflation on a year-over-year basis has come down, but the 3-month view shows little downward momentum. Accordingly, the Bank of Canada put the country on notice that it is leaving the door open to future rate hikes because of the stubborn uncertainty in getting inflationary pressures down.
Yet, the BoC did not proceed with a rate hike. Counterbalances to the increased inflation risks remain. Overall supply and demand in the Canadian economy is almost in balance with the trend favoring excess supply. The BoC also downgraded its outlook for economic growth because the economy slowed more than expected back in July; less excess demand exists than expected.
So while the BoC hiked its expectation for inflation from 3% to 3.5% for next year, the central bank is sticking to its longer-run projection of 2% in 2025. Thus, Macklem felt confident in reassuring Canadians: “with clearer evidence that monetary policy is working, Governing Council’s collective judgment was that we could be patient and hold the policy rate at 5%.“ Interest rates will stay higher for longer and the inflation target remains in sight.
Corporate and Government Behavior Working Against Monetary Policy
Companies and Canadian governments in aggregate are not cooperating with the objectives of monetary policy.
Canadian companies are still passing along price increases to consumers faster than normal. From the Monetary Policy Report:
“Corporate pricing behaviour has yet to normalize. Businesses continue to increase prices more frequently and by a larger amount than normal… This may indicate that households and businesses are, respectively, expecting to pay more and charge more for goods and services. High inflation expectations could also feed into wages.”
I assume this dynamic also comes from lingering excess demand which makes consumers less price sensitive. The coming era of excess supply should work counter to this effect.
During the Q&A Macklem pointed out that the fiscal spending plans are working against monetary policy. Aggregate government plans will grow spending by 500 basis points greater than the potential growth of the Canadian economy. Thus, the economy will add more demand than supply. In the past year, growth in government spending was below 2%. Macklem indicated that it would be helpful if fiscal and monetary policy were “rowing together.” The BoC’s forecasts take into account the potential future inflationary pressure from government spending.
The Canadian Dollar Trade
The bump higher in hawkish rhetoric did not benefit the Canadian dollar, perhaps because the BoC maintained its longer-term expectation for inflation. Weakness in the currency Invesco CurrencyShares Canadian Dollar Trust (FXC) or strength in USD/CAD continued until the Federal Reserve’s last policy announcement. Financial markets painted a dovish interpretation to the accompanying news even though it read like nothing materially changed.
I did not expect the drift higher (with high volatility) in USD/CAD as I accumulated a short position. I continue to hold the position as I see two main factors working against my thesis reaching their own individual extremes.
The biggest shift against my original setup was a big increase in the spread on 10-year yields between U.S. and Canadian bonds. Just over a month ago this spread sat at a level that looked like a potential bottom. Shortly thereafter, the bottom dropped out. The spread was last this wide back in March, 2019. This large spread serves advantage to the U.S. dollar over the Canadian dollar. From World Government Bonds:
Oil has also worked against my original thesis. Oil did not stabilize. While it soon spiked higher in response to Hamas’s attack on Israel, selling in oil resumed in about 10 days. Last week, the United States Oil Fund, LP (USO) hit a 3+ month low. While this decline should reduce the Bank of Canada’s fear that higher energy prices will bleed their way into pressures on core inflation, it also works against the Canadian dollar as a commodity currency. I have dropped any expectation on oil although I am net short USO. From TradingView.com:
From a technical perspective, USD/CAD remains well-supported by its uptrending 50-day moving average (DMA) (the red line below). I still expect this uptrend to break to the downside as the extremes working against the Canadian dollar lose steam. To the upside on USD/CAD I have a clear stop loss point above the peak created by the reaction to the Federal Reserve’s November 1st announcement on monetary policy. From TradingView.com:
Be careful out there!
Full disclosure: short USD/CAD, net short USO (short shares, long call spread)
Why the Excitement? A Q&A on Monetary Policy with Generative AI
Posted: November 8, 2023 Filed under: Jobs, Monetary Policy | Tags: CME FedWatch Tool, employment, Federal Reserve, GDP, generative AI, Goldman Sachs, GS, IPO, Jerome Powell, Monetary Policy, NotebookLM, S&P 500, SPY 6 CommentsI left last week’s Federal Reserve conference call with the impression that nothing had changed. I did not hear any new news. Yet, the post-Fed celebration in the stock market continues at the time of writing. While oversold conditions likely primed the pump for the rebound, the enduring nature of the narrative on monetary policy made me wonder what I missed. For this particular review of the Fed, I reached out to generative AI for assistance. I used Google’s experimental NotebookLM as a partner to query the language in the transcript of the conference call; NotebookLM is free and can accommodate all the text in the Fed transcript. I hoped to uncover the secret message that markets saw, but I failed to see or hear. Instead, NotebookLM essentially agreed with my original assessment of the Fed’s message.
Monetary Policy Question and Answer with an AI
The following question and answer with the generative AI in NotebookLM is like a poor man’s substitute for the Fed’s official Q&A session. Each section of dialogue below starts with a quote from Fed Chair Jerome Powell, followed by my question, and then NotebookLM’s response. All quotes are verbatim with some caveats on NotebookLM’s response in curly brackets.
Powell: “We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.”
Me: “Does Powell express any confidence that inflation is on the path to meeting its objective of 2%?”
NotebookLM: “No, Powell does not express any confidence that inflation is on the path to meeting its objective of 2%. He says that the Fed will continue to raise rates until inflation is under control, and that the two conditions that would lead the Fed to stop raising rates are (1) if inflation is on a path to the Fed’s 2% target and (2) if the labor market is continuing to broadly cool off and achieve a 4% unemployment rate. He does not say that either of these conditions are likely or happening now.” {That second condition is not directly stated in the transcript. NotebookLM must have picked this up from an external commentary. A more accurate characterization would be to drop the specific, quantified unemployment target}.
Powell: “We are attentive to recent data showing the resilience of economic growth and demand for labor. Evidence of growth persistently above potential, or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.”
Me: “What evidence does Powell cite to demonstrate that recent data show the resilience of economic growth and demand for labor?”
NotebookLM: “Powell cites the following evidence to demonstrate that recent data show the resilience of economic growth and demand for labor:
- GDP growth: Powell cites the strong third quarter GDP figures as evidence that the economy is continuing to expand at a strong pace.
- Employment: Powell notes that the labor market remains very strong, with job openings and labor demand still clearly remaining very strong.
- Inflation: Powell acknowledges that inflation is still high, but he argues that the recent data show that inflation is beginning to moderate.”
Powell: “As for the Committee, we are committed to achieving a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time. And we’re not confident yet that we have achieved such a stance.”
Me: “Does the lack of confidence in achieving a sufficiently restrictive monetary policy leave open the possibility for future rate hikes?”
NotebookLM: “Yes, the lack of confidence in achieving a sufficiently restrictive monetary policy leaves open the possibility for future rate hikes.” {The rest of the response provided an incoherent timeline of Fed action}
Powell: “…the way we’re going to be going into these future meetings is to be just determining the extent of any additional further policy tightening that may be appropriate to return inflation to 2 percent over time” (Powell later reemphasized “it’s fair to say that’s the question we’re asking is, should we hike more”)
Me: This statement suggests that the Federal Reserve has a bias toward hiking rates again. What do you think? Explain your reasoning.
NotebookLM: “Yes, Powell’s statement suggests that the Federal Reserve has a bias toward hiking rates again...However, it is important to note that Powell also said that the Fed will “be humble” in its approach to raising rates, and that it will “listen carefully” to the data. This suggests that the Fed is not committed to a specific path for rate hikes, and that it will be willing to adjust its plans if necessary.” {Rest of answer repeated incoherent timeline even after I asked for a different explanation}
Powell: “the Committee is not thinking about rate cuts right now at all. We’re not talking about rate cuts, we’re still very focused on the first question, which is; have we achieved a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time, sustainably? That is the question we’re focusing on. The next question, as you know, will be for how long will we remain restrictive?”
Me: “How would you assess the odds of a rate cut anytime soon based on this comment and the rest of the transcript?”
NotebookLM: “The odds of a rate cut in the near future are low.
- Powell said that the Committee is not thinking about rate cuts right now at all.
- The Committee is focused on bringing inflation down to 2 percent sustainably.
- The Committee will consider a rate cut if inflation comes down and remains low for an extended period of time.
However, it is important to note that the Committee is also considering other factors, such as the strength of the economy and the labor market. If the economy slows down or the labor market weakens, the Committee may be more likely to consider a rate cut.”
I selected quotes that I thought were most likely to produce some insight into the market’s excitement over the prospects for monetary policy. So just to be thorough, I asked NotebookLM one last question: “Is there anything in this transcript that even hints at the possibility for easier monetary policy in the near future? What about prospects for an end to rate hikes? Explain your reasoning only using content from this transcript.”
NotebookLM concluded: “There is no indication in this transcript that the Fed is considering easier monetary policy or an end to rate hikes.” Its explanation was a repeat response to my previous question.
The Persistent Longing for Easier Monetary Policy
With just two months left in the year and earnings season nearing an end, eyes and prognostications turn to 2024. Year-to-date performance remains positive but the market’s three most dangerous months of the year stained market sentiment. Thus, the persistent longing for easier monetary policy is taking on a new urgency. A recent example came from Goldman Sachs (GS) in predicting a strong year for IPOs in 2024. The main reason for the optimism? Rate cuts! From the Yahoo Finance article “The ‘real IPO reopening’ is coming in 2024: Goldman Sachs“:
“Bruun’s case for IPOs to reemerge stems from a core stance repeated throughout Goldman’s 2024 outlook roundtable on Tuesday: The Federal Reserve will cut rates in 2024. And history says that’s usually an opportune time for the IPO market.
‘When expectation moves such that people are anticipating rate declines and are starting to see rates come down, that’s usually when IPOs open up,’ Bruun said.”
This kind of persistent longing for easier monetary policy is likely to pervade financial markets as the assumption of an end to rate hikes takes deeper root in market sentiment and psychology. If rate hikes have ended then, logically, rate cuts must be imminent.
Still, the Fed will also persist in doing what it can to prevent the market from getting ahead of the Fed’s desire to keep driving inflation to its 2% target. I fully expect Fed jawboning in coming weeks and months to do its best to work against the notion that easier monetary policy is on its way soon. Currently, Fed fund futures do not anticipate any more rate hikes, and the first rate cut comes in June. Both projections are the exact same as they were before the November 1st meeting. Thus this lack of change still has me scratching my head about a renewed excitement over the prospects for monetary policy. From the CME FedWatchTool (the blue boxes indicate the market’s projection for the most likely target for the Fed’s interest rate range the given meeting date in the first column):
The S&P 500
Finally, here is a close-up of the daily trading action in the S&P for perspective on the scale of the market’s recent excitement. Market breadth over this time period went parabolic. (image from TradingView.com)
A Stall in Canada’s Core Inflation Narrative
Posted: September 19, 2023 Filed under: Canada, CPI, Currencies, Economy, Housing | Tags: Bank of Canada, BoC, Canadian dollar, CPI, FXC, Invesco CurrencyShares Canadian Dollar Trust, Statistics Canada, USD/CAD Leave a commentWhat a difference 5 months can make. Canada’s inflation trend has apparently transitioned from a steady decline to a stall. The last two months of failed progress looks like a bottoming process when compared to the previous trend. This stalling also confirms the Bank of Canada’s concern in July about the loss of the benefits of the base effects that helped drive the inflation trend downward. The chart below comes from Statistics Canada in its August CPI report.
Back in April, the Bank of Canada (BoC) described a goldilocks narrative on inflation. This narrative featured the annual change in the Consumer Price Index inflation (CPI) gradually returning to the 2% target at the end of 2024 with economic growth picking up alongside inflation’s downward glide path in 2024. Just two months later in June, the Bank of Canada raised concerns about stubborn inflation and on-going high excessive demand. Accordingly, the BoC took its finger off the pause button on rate hikes and wrote an insurance policy on inflation with one more rate hike. The latest stall in inflation’s trend caused market expectations of a rate hike in October to surge from 23% to 42%.
The Canadian dollar surged along with rate hike expectations. The Canadian dollar was already rallying against the U.S. dollar (USD/CAD) going into the inflation print despite the U.S. dollar’s strength against other major currencies. The chart below shows how the Invesco CurrencyShares Canadian Dollar Trust (FXC) gapped higher at the open but faded from the intraday high. While the intraday action may represent an element of sell on the news, I think the path of least resistance is higher for the Canadian dollar until some new inflation data contradicts the revival of inflation concerns. I sold a small position short on USD/CAD to take advantage of the small fade.
I am not expecting the Federal Reserve’s coming announcement on monetary policy to change the trajectory. Accordingly, I will add to my position if USD/CAD rebounds further.
Drivers of Core Inflation
Core inflation was supported by accelerating rent prices. Ironically, Statistics Canada partially blamed high mortgage rates which are of course higher thanks to the BoC’s rate hikes to fight inflation:
“Shelter prices were up 6.0% on a year-over-year basis in August, after increasing 5.1% in July. Faster growth in shelter prices was led by the rent index, which rose 6.5% year over year nationally, after a 5.5% gain in July. Among other factors, a higher interest rate environment, which may create barriers to homeownership, put upward pressure on the index.”
Presumably, the higher mortgage rates are forcing more people than usual to choose renting over buying and in turn pressuring vacancy rates. Lower vacancy rates tend to push rent prices higher.
I might next need to write about a Canadian inflation conundrum!
Be careful out there!
Full disclosure: short USD/CAD
What Powell Missed In His Jackson Hole Speech Explaining Inflation’s Drivers
Posted: August 25, 2023 Filed under: Bond market, Economy, Monetary Policy, Stock Market | Tags: Federal Reserve, iShares 20+ Year Treasury Bond ETF, Jackson Hole, Jerome Powell, Monetary Policy, S&P 500, SPY, TLT 2 CommentsFederal Reserve Chair Jerome Powell included a neat and tidy explanation of the drivers of inflation in today’s Jackson Hole Speech titled “Inflation: Progress and the Path Ahead.” However, Powell missed one of the key drivers that fanned the flames of all the other drivers: the Fed held interest rates too low for too long and left overall monetary policy extremely accommodative long after it was needed. In early June I laid out that case in detail combining the research of economists Gauti B. Eggertsson (Brown University) and Don Kohn (Hutchins Center on Fiscal & Monetary Policy, Brookings Institution) and my previous claims about the Fed’s role in creating high inflation. As a reminder here are the key points for the case of Fed-driven inflation:
- The Fed’s revised monetary policy framework in 2020 contained an inherent inflationary bias.
- The Fed relied too heavily on hawkish hints in the months leading into the lift-off for monetary policy.
- The Fed recognized too late that the labor market was sufficiently tight for higher rates.
Powell made no mention of any of these factors in his Jackson Hole speech. Instead, Powell provided a one sentence summary of the inflation narrative: “The ongoing episode of high inflation initially emerged from a collision between very strong demand and pandemic-constrained supply.” Even in describing the path to lower inflation, Powell avoided saying that the Fed needs to unwind overly accommodative monetary policy: “By the time the Federal Open Market Committee raised the policy rate in March 2022, it was clear that bringing down inflation would depend on both the unwinding of the unprecedented pandemic-related demand and supply distortions and on our tightening of monetary policy.” Inflation has to unwind itself along with the assistance of tightening policy.
Powell went on to provide a very familiar narrative about inflation:
- The Russian invasion of Ukraine has driven up headline inflation.
- “Demand for vehicles rose sharply, supported by low interest rates, fiscal transfers, curtailed spending on in-person services, and shifts in preference away from using public transportation and from living in cities. But because of a shortage of semiconductors, vehicle supply actually fell.” At least Powell acknowledged low interest rates helped drive excess demand for vehicles.
- “In the highly interest-sensitive housing sector, the effects of monetary policy became apparent soon after liftoff. Mortgage rates doubled over the course of 2022, causing housing starts and sales to fall and house price growth to plummet. Growth in market rents soon peaked and then steadily declined.” Here Powell chose to focus on the impact of higher rates on housing which of course implies that lower rates supported housing demand. He avoided noting how unnaturally low interest rates drove the housing market to mania levels of demand and pricing.
- “Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight.” Nonhousing services inflation presents the Fed with its most troublesome driver of inflation. Powell noted that inflation in this sector has “moved sideways” since monetary tightening began.
A stronger than expected economy is the upshot to the current inflation story. This above trend economic growth could force the Fed to continue hiking rates higher and for longer than current expectations. In fact, this economic strength is the exact opposite of what so many economists, pundits, and analysts have expected for 18 months or so. The most anticipated recession in U.S. history just refuses to materialize.
The current uncertainty leaves financial markets nervous. The U.S. dollar (DXY) is stronger than expected at this part of the cycle, the entire rate curve is moving higher, and the stock market looks wobbly. The NASDAQ (COMPQ) and the S&P 500 (SPY) have returned to their last highs preceding Jackson Hole 2022. What I have called the “summer of loving stocks” has already lost all its gains from July. August is just the first month of the three “most dangerous” months in the stock market. So even as the stock market approaches oversold trading conditions, obligatory rebounds may be insufficient to stave off a rollback of all the summer gains.
The S&P 500 (SPY) is confirming a failure at 50DMA resistance on its way to what looks like a more direct test of support from the high prior to Jackson Hole 20222.
The iShares 20+ Year Treasury Bond ETF (TLT) is challenging its lows from October and November. A further breakdown could trigger a fresh wave of selling in the stock market.
Be careful out there!
Full disclosure: long TLT put spread
Is the British Pound Topping Despite Lingering Strength in UK Core Inflation?
Posted: July 21, 2023 Filed under: Currencies, United Kingdom | Tags: British pound, CPI, CPIH, GBP/USD, inflation expectations, Office for National Statistics, technical analysis, United Kingdom Leave a commentExpectations can define reactions to news in financial markets. Forecasts for June inflation in the UK ran a little hot after May’s inflation report caught forecasters flat-footed. So when June inflation numbers came in lower than expected, financial markets experienced a sharp bout of relief. Expectations for rate hikes from the Bank of England moderated and took the British pound (GBP/USD) down with them. While the pound drifted lower after May’s inflation report, the pullback this time around was abrupt and sharp. Yet, the market may have overreacted given core CPIH (Consumer Prices Index including owner occupiers’ housing costs) continues to trend higher (core CPIH excludes energy, food, alcohol & tobacco). Core CPIH barely budged in June and left the uptrend intact even as consumer and headline inflation has clearly peaked.
The above graph shows that services inflation is the main culprit keeping core CPIH in an uptrend. Core CPIH dropped from 6.5% in May to 6.4% in June. Since May was a 30-year high, I am particularly unimpressed by the “pullback” in the core inflation rate. The Core CPI (Consumer Prices Index) dropped from 7.1% in May, a 31-year high, to 6.9% in June.
Food and energy inflation is coming off extreme levels. Food inflation is coming off a peak 19.2% in March, 2023. Fuel prices are outright plummeting, falling 13.1% in May and 22.7% in June.
The British Pound Cools with Inflation
The cooling overall inflation numbers cooled the heels of the British pound which has been on quite a streak since the bond and currency crisis 10 months ago. GBP/USD, also Invesco CurrencyShares British Pound Sterling Trust (FXB), was falling off a near 16-month high coming into the inflation print. The inflation report greased the skids on the way to an important test of the uptrending 20-day moving average (DMA). That line has held as support since the beginning of June and has been important support since early March.
Source: TradingView.com
For now, I am trading for a bounce from the 20DMA and prepared to to accumulate a larger position for a test of 50DMA support. The overall drivers of sterling strength seem intact as long as core inflation is uptrending or even just sticky. The Bank of England will have to remain as hawkish as ever.
Of course, the upcoming meeting of the U.S. Federal Reserve is a major wildcard. If the Fed manages to get hawkish enough to scare some fresh strength into the U.S. dollar, then I will have to drop my current trading strategy.
Regardless, the uptrend in the pound should at some point end in the coming months. This recent weakness in the currency could be the beginning of the end.
Be careful out there!
Full disclosure: long GBP/USD
Base Effects Add to the Bank of Canada’s Inflation Concerns
Posted: July 13, 2023 Filed under: Canada, Economy, Monetary Policy | Tags: Bank of Canada, base effects, FXC, Invesco CurrencyShares Canadian Dollar Trust, Monetary Policy, USD/CAD 1 CommentLast month, the Bank of Canada worried about inflation staying more persistent than expected and decided to release the pause button on rate hikes. In this month’s Monetary Policy Report, the Bank of Canada added “base effects” to its list of concerns about stubborn inflationary pressures (emphasis mine):
“While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation. With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation. Moreover, with three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank’s business surveys, which find businesses are still increasing their prices more frequently than normal.”
I have seen more and more references to base effects regarding U.S. inflation. In the previous two years, base effects could be used to dismiss inflation’s threat. This year, base effects from more challenging comparables are looming as the end of the tailwinds for disinflation (on a year-over-year basis). The timing is poor. As the Bank of Canada noted, underlying inflation has gone nowhere for almost a year. At this point, sticky inflationary pressures cloak more uncertainty around prior inflation expectations:
“In the July MPR projection, CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.”
Surprisingly, markets took the news in stride. At the same time the U.S. stock market celebrated a pleasing report on U.S. June inflation, the Bank of Canada’s rate hike did not dampen spirits about the prospects for a more dovish Federal Reserve. Currency markets reacted as though the Fed might even be closer to rate cuts as losses in the US. dollar continued apace.
In fact, the market almost seemed to skip right over the Bank of Canada’s news. While majors like the euro and the British pound rallied all day against the U.S. dollar, the Canadian dollar enjoyed just brief intraday strength in the wake of the Bank of Canada’s decision to hike rates another 25 basis points. At the time of writing, USD/CAD is only just now returning to its low point following the rate hike (and looks stalled right at support).
On a daily basis, the Canadian dollar looks set to resume its momentum against the U.S. dollar IF USD/CAD breaks below yesterday’s low. Otherwise, a countertrend rebound could take USD/CAD right back to downtrending resistance at the 50-day moving average (DMA) (the red line below) as the next move.
I remain bearish on USD/CAD (bullish the Canadian dollar), and I expect rallies to continue to fail just as they have since September. The path downward on USD/CAD (upward for Invesco CurrencyShares Canadian Dollar Trust (FXC)) has been slow and choppy yet ever so slightly biased toward more relative strength for the Canadian dollar. The next major test comes with the Federal Reserve’s meeting later this month. More Fed hawkishness at that time could refresh the U.S. dollar against all majors for a spell.
Be careful out there!
Full disclosure: no positions
Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge
Posted: June 10, 2023 Filed under: Economy, Monetary Policy | Tags: Brookings Institution, Don Kohn, Federal Reserve, Gauti B. Eggertsson, James Bullard, Jerome Powell, Monetary Policy, pandemic, Policy Framework, Robert Kaplan, unemployment, vacancy-unemployment ratio 2 CommentsValidation That Monetary Policy Was Overly Accommodative for Too Long
When the Federal Reserve changed its framework for monetary policy in August, 2020, it sounded to me like an over-reaction to the pandemic era economic malaise. Looking back, I describe that moment as peak deflationary thinking. This peak is marked by an assumption that the economy is stubbornly stagnant and biased for lower aggregate prices without the Fed’s on-going vigilance and active interference. It turned out that the pandemic delivered just the right mix of sustained economic distortions and excessive liquidity to create “persistently elevated, unactionable inflation“. In December, 2022, I explained the Fed’s challenge and the attempt at course correction in “How To Trade The Fed’s Designed Over-Correction For Inflation“:
“In the immediate aftermath of the pandemic, the Fed announced an important policy shift at that year’s Jackson Hole gathering. Going forward, the Fed would target average inflation of 2% instead of 2% as a point destination. Moreover, the Fed crystalized its goal to drive unemployment as low as possible via ‘assessments of the shortfalls of employment from its maximum level.’ Years and decades of deflationary drags facilitated this shift, and the economic crisis from the pandemic seemed at the time to further entrench these deflationary forces. Interest rates seemed destined to stay lower for longer…I claim this policy framework encouraged the Fed to be overly optimistic about the transitory nature of pandemic-era inflation, and subsequently compelled the Fed to move late toward normalizing monetary policy.”
My claims that the Fed left rates too low for too long in its ambitious effort to drive unemployment as low as possible received a resounding validation in “The Inflation Surge of the 2020s: The Role of Monetary Policy,” a “conference draft” authored by economists Gauti B. Eggertsson (Brown University) and Don Kohn (Hutchins Center on Fiscal & Monetary Policy, Brookings Institution). Eggertsson presented the paper on May 23, 2023 during a 3-hour conference at the Brookings Institution titled “The Fed: Lessons learned from the past three years” (Eggertsson’s 27-minute portion starts at the 1:25 mark).
How the Fed’s Revised Policy Framework Contributed to the Inflation Surge
In this paper, Eggertsson and Kohn explore how the Federal Reserve’s monetary policy contributed to inflationary pressures in the U.S. between 2022 and 2023. In their research, they describe the inflation surge that began in March 2021 as “the largest and most persistent increase in inflation since the Great Inflation of the 1970s.” This inflation surge was unanticipated and its persistence was consistently underestimated by policymakers and economists (as well as a wide array of pundits and analysts who invariably insisted that high prices would be sufficient brakes on demand to cure inflation before economic damage occurred).
Just as I claimed the 2020 Policy Framework was the genesis of the Fed’s monetary problem with inflation, the authors did the same. They note that there were two major changes in this Framework from the 2012 version. The first change was the adoption of the Flexible Average Inflation Targeting (FAIT). This policy states, “if inflation persistently undershoots the 2 percent target it will be offset by deliberate ‘moderate’ overshoots ‘for some time’ to better assure that inflation averages 2 percent over time.” The second change was the shift to an asymmetric response to labor market deviations from “maximum employment.” This means that policy would be influenced by shortfalls from maximum employment rather than estimated or projected overshoots. Importantly, Eggertsson and Kohn propose that “an asymmetric objective function, coupled with the common assumption that policy affects activity with a lag, implies an inflationary bias.” (The paper’s appendix includes a mathematical representation of this claim).
The authors suggest that the new Framework was largely predicated on the belief that the tightness of the labor market had a limited impact on inflation. This belief was informed by the 2015 experience when unemployment declined from 5.0% to 3.7% while inflation was still undershooting the 2% target. Extrapolating from this lesson, the 2020 Framework assumed employment could expand for longer without generating inflationary pressures. Thus, there was no need to reduce accommodation preemptively as the labor market tightened.
The authors critique the 2020 Framework’s reliance on reaching maximum employment and inflation at or above 2% before increasing interest rates. This precondition led to what they call “additional inertia to the policy process,” as it limited the Federal Reserve’s ability to adapt to unexpected economic circumstances. The authors note that “forward guidance in September 2020 was well designed to avoid a repeat of a pre-emptive tightening after 2015 when there was high employment but low inflation, it was less well suited for a situation in which it was the other way around.” The forward guidance in September 2020 took its marching orders from the newly updated Policy Framework.
The inflation surge of the 2020s, beginning in the first quarter of 2021, was a sudden and underpredicted economic event. The authors observe that even after the inflation surge began, “Policy makers and the professional forecasters persistently predicted inflation to fall back toward the 2 percent target reasonably promptly.” Base effects from the brief plunge in prices after the pandemic also clouded assessments of the inflation risks. Yet, as the authors explain, “By some metrics the inflation objectives of FAIT (flexible inflation targeting) had been reached in the spring of 2021.” The Fed did not start to hike rates for another year.
Hawkish Hints Were Not Sufficient to Fight Inflation
While the Fed failed to hike rates for that year, they DID drop some hints that inflation was becoming a problem. Eggertsson and Kohn provide a timeline showing the snail’s pace of change in the Fed’s statements on monetary policy over that time, but they use it to explain the lag in policy. Statements between meetings reveal some increasing concerns despite the reluctance to act. For example, in June, 2021, I described how statements from Fed Chair Jerome Powell during the monetary policy press conference that month combined with post-meeting commentary from James Bullard, the president and CEO of the Federal Reserve Bank of St. Louis, to give the Fed a hawkish bias. Yet, despite the expressed surprise at the strong trajectory for inflation, Powell reassured the audience that “lift-off” for rates would leave policy accommodative…just as the 2020 Policy Framework counseled them to act.
The authors reference Robert Kaplan of the Dallas Fed, a dissenter to the September 2020 forward guidance, as an early voice of caution that the Fed apparently decided to ignore. Kaplan co-authored a paper with other researchers at the Dallas Fed in May, 2021 that concluded the labor market was much tighter than indicated by traditional metrics. Eggertsson and Kohn lament that the warning “…seemed to have little effect on the official narrative of the FOMC at the time.” I am not surprised given the weak conclusion of the paper. The following quote reads like an advisory or footnote instead of a prescription or recommendation for a policy change:
“In this post, we wish to suggest that policymakers should be cognizant of a range of supply factors that may currently be weighing on employment. These factors may not be particularly susceptible to monetary policy.
We would expect that many of these factors will fade as the year progresses, increasing the number of job seekers and potentially reducing labor market tightness. However, it is also possible that labor supply will increase less than expected. It is our view that this possibility should be kept in mind as policymakers assess the appropriate stance of monetary policy.”
Note how Kaplan et al even provide an out for monetary policy to stand by and do nothing by suggesting that factors weighing on employment supply are outside the sphere of influence of monetary policy. They did not take the extra step of suggesting that monetary policy was overly accommodative given the inflationary structure of the economy. Their hints were not sufficient.
To wit, with rising speculation about the timing for rate hikes, Powell stuck his neck out in August, 2021 to issue reassurances. Whatever hawkishness hovered over the Fed evaporated in that moment. The Fed would remain focused on tapering with no implication for rates. The hints of hawkishness were simply not sufficient. They did not and could not serve as inflation control.
The focus on tapering also created drag on monetary policy. Eggertsson and Kohn pointed out that the completion of asset purchases became a prerequisite for raising rates. This condition not only resulted in an unnecessary delay but also committed the Federal Reserve to providing far-in-advance notice on how and when asset purchases would be completed.
The Labor Market Was Sufficiently Tight
As the Fed dragged its feet, the labor market tightened to historic levels. The unemployment rate did not tell the full story. Eggertsson and Kohn show how the vacancy-unemployment ratio (v/u) shot up to 0.88 by March, 20221. This level was higher than the average ratio pre-pandemic. The ratio kept climbing persistently and sharply from there. It surpassed 1 by May 2021 and went over 2 by the time the Fed finally started hiking rates in March. The vacancy-unemployment ratio was last that high during World War II. The consistent and linear increase in the first 2 years of the pandemic is truly astonishing.
Source: Eggertsson and Kohn
The authors also stress the importance of understanding the non-linearity of the Phillips curve, an economic principle that shows the relationship between unemployment and inflation. If the labor market was tight enough for these non-linearities to become quantitively significant, this “tightness of the labor market, as measured by v/u, not only gave the Federal Reserve a reason to declare it had satisfied the forward guidance of September 2020” but also indicated that failing to recognize this tightness could have been a major source of the inflation surge.
The Inflation Overshoot
By the time Powell spoke about excessive inflationary pressures in the days after the first rate hike, inflation was well into its overshoot. According to the authors, commitments to the new Policy Framework combined with the uneven and unprecedented nature of the recovery created an inflation overshoot. This inflation overshoot did not have a clear boundary due to the newly imposed condition of achieving maximum employment before raising rates. Additionally, gauging maximum employment was considerably challenging due to the uneven nature of the recovery. Traditional metrics, such as the unemployment rate, proved to be poor proxies for maximum employment under these circumstances. The Fed unwittingly locked itself into implementing the most aggressive campaign of rate hikes since the Paul Volcker days of the early 1980s.
Conclusion: Lessons Learned?
In late November, 2022, Powell claimed he learned his lessons from what I call peak deflationary thinking. In commenting during the Q&A at a Brookings Institution conference at the time, I made the following observation:
“Powell suggested that he would not repeat the ‘mistake’ of counting on the long history of low inflation as a basis for making policy. Powell noted that policy must take into consideration tail risks and their costs. Such acknowledgement forms the foundation of today’s risk management framework. However, Powell remained consistent with earlier Fed claims that starting monetary tightening earlier would not have materially impacted the path for inflation. He insisted that the mistake from two years ago has nothing to do with today’s inflation; he relegated the mistake to a footnote.”
With this attitude, the Fed is not likely to learn the lessons Eggertsson and Kohn hope the Fed takes away from this experience. Instead, the new risk going forward is that the Fed concludes the current Policy Framework just got “unlucky.”
Still, Eggertsson and Kohn are hopeful. Moving forward, they suggest that the next policy framework should be subjected to a variety of stress tests and scenarios. Also, in the next framework review, a central question should be whether the benefits hoped for by evaluating deviations of employment from its maximum level can instead be addressed by alternative tools and techniques.
Eggertsson and Kohn also explain, “Like the criteria for adjusting policy, forward guidance needs to build in flexibility in timing and sequencing to adapt to changing circumstances.” They further note that forward guidance and the policy it implies should not only focus on achieving the Federal Reserve’s goals at a particular point in time but also maintaining prices and employment around those goals after they are reached.
Perhaps ironically, these suggestions sound like a data-dependent orientation which the Fed typically professes to follow.
During his presentation, Eggertsson admitted that he was formerly on “team transitory.” A Japanese paper even interpreted him as saying that inflation was not a problem, the proverbial “there is nothing to see here.” His research and retrospective have dramatically changed his understanding and conclusions. Yet, I think he and his co-author are too charitable in claiming that “with the benefit of hindsight, we see several broad problems with the framework and forward guidance that leads to lessons learned for the future frameworks and policy execution.” Their work decisively demonstrates that the necessary signals, signs, and data were readily available for the Fed to act upon sooner. The Fed was anchored by its commitment to a Policy Framework with an inflationary bias. Going forward, policy frameworks must be much less gospel and much more responsive.
Today’s Fed is in risk management mode out of necessity. While people can endlessly debate about the risks and their quantification, this kind of circumspection is an appropriate response to this era of heightened economic uncertainty. Noble goals like driving unemployment down as low as possible in the short-term must take second seat to practical goals like sustaining long-term financial stability.
Be careful out there!
Stubborn Inflation and Excess Demand Spook the Bank of Canada
Posted: June 8, 2023 Filed under: Canada, Currencies, Economy, Monetary Policy | Tags: Bank of Canada, Canadian dollar, Federal Reserve, Monetary Policy, technical analysis, USD/CAD 3 CommentsIn its April decision on monetary policy, the Bank of Canada (BoC) outlined a case for a goldilocks landing for the Canadian economy. While admitting its inflation fight was not yet over, the BoC declared that inflation was “coming down quickly” alongside modest economic growth. The BoC subsequently held interest rates steady in April and May. For June, the bank delivered the sobering news that instead of coming down quickly, “underlying inflation remains stubbornly high.” The statement even included an ominous warning on stubborn inflation and excess demand: “with three-month measures of core inflation running in the 3½-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target.” Accordingly, the Bank of Canada hiked its overnight interest rate another 25 basis points to 4¾%. The immediate reaction in the currency market sent USD/CAD, the U.S. dollar versus the Canadian dollar (or the inverse of Invesco CurrencyShares Canadian Dollar Trust (FXC)), down to recent lows before buyers stepped in to defend support at those lows.
USD/CAD looks primed to break through support from the April and May (intraday) low. Source: TradingView.com
The decision to hike rates followed on the heels of a surprise interest rate hike from the Reserve Bank of Australia. The RBA warned that the country’s 7% inflation “is still too high and it will be some time yet before it is back in the target range.” The growing realization across the globe that inflation could remain stubbornly high runs counter to the narrative that the peak in inflation also means the imminent end of inflationary pressures. Central banks will have to keep fighting. The BoC referred to this global realization despite weakening macroeconomic conditions: “While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability.”
Still, economic conditions in Canada surprised the BoC to the upside. Q1 GDP growth came in at 3.1%. A tight labor market is combining with increases in spending on “interest-sensitive goods” to generate consumption that is “surprisingly strong and broad-based.” Under these conditions, the BoC has plenty of cover to get off the fence and hike again.
The Trade
The technicals are looking ever so slightly better for the Canadian dollar to deliver a major breakthrough against the U.S. dollar. I thought April’s break of support at the 200-day moving average (DMA) (the bluish line in the above chart) signaled the big breakthrough. Instead, USD/CAD proceeded from there to pivot around its 200DMA. However, the double peak in April and May firmed my preference to go long the Canadian dollar. Now the currency pair is challenging the support from the April and May lows which ended a subtle series of higher lows since August of last year. Perhaps most importantly, if and when the U.S. Federal Reserve finally gives in to the market’s expectations for rate cuts, I expect the Canadian dollar to be a prime beneficiary with the potentially bullish implications for commodities.
Be careful out there!
Full disclosure: short USD/CAD
Fed’s Bostic: Still Comfortable Leaning Into Tight Labor Markets
Posted: May 25, 2023 Filed under: Currencies, Economy, Monetary Policy | Tags: DXY, DXY0, Fed Fund Futures, Federal Reserve, initial claims, Raphael Bostic, technical analysis, U.S. dollar 1 CommentI have argued for a while that as long as the labor market remains tight with low unemployment, the Federal Reserve will press as far as it dares on its cycle of monetary tightening. Raphael Bostic, CEO of the Atlanta Federal Reserve (and currently a non-voting member of the Federal Open Market Committee), confirmed that strategy during a recent interview with Marketplace.
Don’t Come Crying to the Fed Anytime Soon
Bostic definitively stated that the Fed is so determined to press against inflation that it will likely turn a deaf ear to those who will ask for easier monetary conditions the moment the labor market delivers bad news. Emphasis mine:
“You know, as we get further into inflation getting, closer to our target, I’m expecting we’re going to see stresses in labor markets. We’ve not really seen that. And when that starts to happen, people are going to be looking to us to try to do something about that as well, and maybe turn away from our focus on inflation. But we can’t do that, because failing in getting the inflation back to the 2% target will be much more problematic for the economy. And so as people start to call out for action to provide relief in labor markets, I think what we’re going to have to do is just stay laser focused on the fact that, you know, our employment mandate goal, we are very, very close to that right now. And we’re not close to that in inflation. So we have to stay focused on inflation.”
The bad news for the labor market has been long anticipated and stubbornly absent for the people who keep expecting a recession at every turn of the calendar. This “lagging indicator” of economic health just keeps chugging along. Even a recent uptick in initial unemployment claims above 240,000 fizzled out before the “I told you so’s” could drape the economic headlines. The 251,000 in weekly initial claims from January, 2022 stands as the latest high. For now, initial claims continues to tell the same message week after week after week: the Fed has room to hike if inflation remains an issue. Rate cuts are certainly nowhere on the horizon from this vantage point.
Source: U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; May 25, 2023.
Given this data and Bostic’s determination to ignore anyone who wants the Fed to cut rates into an inflationary environment, I understand Bostic’s best guess target for rate cuts set a year or more out from now.
“My best case is that we won’t be thinking about a cut until well into 2024. And, you know, inflation is just double what our target is by just about every measure. I don’t see scenarios where the economy is going to evolve in a way such that inflation gets close enough to our target where we might contemplate any kind of cut.”
As of the time of writing, Fed fund futures have acquiesced to the likelihood of another rate hike by July. However, they still eagerly anticipate rate cuts as soon as November. By the time Bostic guesses the Fed will think about cuts, the futures think the Fed will have 6 or 7 rate cuts in the books. The persistently wide gulf between Fed and market expectations on rate policy remains one of the more remarkable features of today’s financial markets.
Fresh Wind for the U.S. Dollar
The market’s push for another rate hike by July has helped the U.S. dollar regain momentum. Strength particularly against the euro and the Japanese yen has the dollar index (DXY) bouncing off its lows for the year. I am riding this momentum as long as it holds up. If the rally continues from here, I expect fresh resistance at the year’s high which should also coincide at the time with critical resistance from the 200-day moving average (DMA) (the bluish line below).
Source: TradingView.com
Be careful out there!
Full disclosure: net long the U.S. dollar
Reserve Bank of Australia Revives the Ghost of Inflation Past
Posted: May 3, 2023 Filed under: Australia, Economy | Tags: AUD/JPY, AUD/USD, Australian dollar, Japanese yen, Monetary Policy, RBA, Reserve Bank of Australia 1 CommentAfter the Reserve Bank of Australia (RBA) decided to leave its interest rates unchanged last month, the Australian dollar sold off for a week against the U.S. dollar. The decline reversed the small rally leading into the decision on monetary policy. AUD/USD enjoyed a small rebound going into the May decision on monetary policy and then jumped after the RBA threw markets for a loop by hiking interest rates again. More importantly, the RBA quickly revived the ghost of inflation past. The RBA undermined any assumptions that it would be content to watch inflation try to guide itself from 7% down to the 2% to 3% target range. The previous pause in rate hikes did not seal the deal on the fight against inflation.
The 15-minute chart of AUD/USD shows how traders rushed to buy in the wake of a surprise rate hike. The enthusiasm peaked within 3 hours. (Source: TradingView)
The RBA acknowledged that “inflation in Australia has passed its peak.” However, inflation at 7% is too high and “…while the recent data showed a welcome decline in inflation, the central forecast remains that it takes a couple of years before inflation returns to the top of the target range.” This inflation horizon means the RBA could intermittently hike rates for quite some time as it scours the landscape for smoldering embers of inflation.
The current problem is in services price inflation. The U.S. also faces this challenge. Indeed, he RBA referenced global commonality in explaining the sources of stubborn highly inflation (emphasis mine):
“Goods price inflation is clearly slowing due to a better balance of supply and demand following the resolution of the pandemic disruptions. But services price inflation is still very high and broadly based and the experience overseas points to upside risks. Unit labour costs are also rising briskly, with productivity growth remaining subdued…Wages growth has picked up in response to the tight labour market and high inflation.”
The RBA further explained that the rate hike should firmly anchor medium-term inflation expectations. Tightening monetary policy is acting like an insurance policy against higher inflation expectations contributing “to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the historically low rate of unemployment.” Unemployment in Australia remains at a 50-year low. Thus, the RBA has plenty of room to continue tightening as needed…at least for now. The RBA acknowledged the challenge ahead in avoiding a recession while it tightens monetary policy: “the path to achieving a soft landing remains a narrow one.”
The RBA concluded the May statement on monetary policy just as it ended the previous statement: “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.” In other words, the market will need to stay on its toes.
The Trade
The intraday surge in AUD/USD was not enough to punch the currency pair through important resistance on the daily level. AUD/USD remains trapped underneath resistance from all three major trendlines: the 20-day moving average (DMA) (dashed line), 50DMA (red line), and the 200DMA (blue line). Thus, I am neutral on AUD/USD until at least after I see how the market responds to the Federal Reserve’s turn to announce monetary policy.
AUD/USD has been stuck in a range for two months. Resistance from the 20DMA, 50DMA, and 200DMA are now capping upside. (Source: TradingView)
The Australian dollar versus the Japanese yen (AUD/JPY) is much more interesting, especially with the Australian dollar holding a significant yield advantage. The Japanese yen is suffering a fresh bout of weakness because the new governor of the Bank of Japan confirmed that he has little interest in tightening policy from ultra low rates. The double dose of yen weakness and Australian dollar strength hurled AUD/JPY right into overhead resistance at the 200DMA. A rush to the “safety” of the yen in the wake of fresh selling in the U.S.’s regional banks help send AUD/JPY in reverse. Still, while the 200DMA held as resistance, AUD/JPY is now making higher highs and higher lows with the 20DMA in an uptrend. The current 50DMA breakout could hold given this fresh momentum. (Recall that a bullish AUD/JPY has bullish implications for the stock market).
Overall, with the RBA on a path that could include higher rates for some time, I like buying the Australian dollar on dips on the assumption it has likely bottomed against the U.S. dollar and the Japanese yen. I am currently (re)accumulating AUD/JPY on this pullback in anticipation of an eventual retest of 200DMA resistance.
AUD/JPY has traded in a well-defined range all year. The latest uptrend is the latest opportunity to build enough momentum to break out. (Source: TradingView)
Be careful out there!
Full disclosure: long AUD/JPY, long FXA
A Golden Inflation Conundrum
Posted: April 17, 2023 Filed under: commodities, CPI, gold, Monetary Policy, PPI | Tags: abandoned baby top, Christopher J. Waller, Consumer Price Index, CPI, Federal Reserve, gld, inflation expectations, Monetary Policy, PPI, Producer Price Index, SPDR Gold Shares, technical analysis, University of Michigan surveys of consumers Leave a commentLast week, SPDR Gold Shares (GLD) rallied on weak inflation news and pulled back on strong inflation news. The gap up in GLD followed by a gap down created the dreaded “abandoned baby top.” This technical pattern typically signals the end of a rally. What gives with this golden inflation conundrum?
SPDR Gold Shares (GLD) printed a technical topping pattern amid mixed inflation news, but it is trying to hold uptrending support at the 20-day moving average (DMA)
The Conundrum
The current inflationary cycle could be ending, at least in North America. For example, the Bank of Canada (BoC) showed inflation data with a steeply descending trend ending with a near perfect landing at the Bank’s 2% target in late 2024.
Here in the U.S. plenty of pundits have declared inflation a non-threat ever since the Federal Reserve finally got serious about it. Cathie Wood has been one popular critic of the Fed’s inflation concerns. The disbelievers received more confirming evidence when the latest producer price index told a disinflationary story. A slightly weaker than expected inflation reading from the March Producer Price Index (PPI) generated cheer in stocks given the implication for looser monetary policy. Since producer prices sit upstream from final goods prices, PPI can be a leading indicator of future prices.
Gold also celebrated the soft inflation numbers; GLD gained 1.4%. This reaction represents the upside of the golden inflation conundrum. Gold bugs suspect that the seeds of inflationary pressures remain well-grounded in the economy. I agree with them. A relaxed Fed is a potential catalyst for rewatering the garden of growing prices, especially if labor markets remain tight. Thus, the prospect of a relaxed Fed supports higher gold prices.
The downside of the golden inflation conundrum can come on stronger inflation signals because they support an aggressive, inflation-fighting Fed. GLD went into retreat in the wake of a surprising surge in consumer expectations for inflation next year from 3.6% in March to 4.6% in April. This reading from the University of Michigan’s surveys of consumers was last this high in November, 2022. Even if this move coincided with the jump in gas prices, surges in inflation expectations are sure to encourage the Fed to stay on message. As it happened, the market got a timely dose of messaging from Governor Christopher J. Waller the same day.
The Fed Stays On Message
In the wake of the economic data, Governor Christopher J. Waller spoke at the Graybar National Training Conference in San Antonio, Texas. Waller reiterated the all too familiar refrain “inflation remains much too high.” He provided the following cautionary assessment of inflation (emphasis mine):
“Inflation moderated in the second half of 2022, but that progress more or less stalled toward the end of the year…On April 12, we got consumer price index (CPI) inflation data for March, and it was another month of mixed news…Core inflation, which strips out food and energy prices, is a good guide to future inflation, and that measure came in at around 0.4 percent in March, which translates to an annual rate of 4.6 percent if it were to persist. It was the fourth month in a row with core inflation at 0.4 percent or higher. Since December of 2021, core inflation has basically moved sideways with no apparent downward movement. So, despite some encouraging news on a slowing in housing costs, core inflation does not show much improvement and remains far above our 2 percent inflation target.
Whether you measure inflation using the CPI or the Fed’s preferred measure of personal consumption expenditures, it is still much too high and so my job is not done. I interpret these data as indicating that we haven’t made much progress on our inflation goal, which leaves me at about the same place on the economic outlook that I was at the last FOMC meeting, and on the same path for monetary policy. Because financial conditions have not significantly tightened, the labor market continues to be strong and quite tight, and inflation is far above target, so monetary policy needs to be tightened further. How much further will depend on incoming data on inflation, the real economy, and the extent of tightening credit conditions.”
With the Fed’s next decision on monetary policy just two weeks away, Waller’s words suggest that the Fed could raise rates yet again. The odds are low of getting a disinflationary signal strong enough to counter Waller’s observations. Thus, I think GLD will struggle to invalidate the technical topping pattern for the time-being.
The Trade
The golden inflation conundrum leaves GLD in a contrary place. In the short-term, GLD’s best chances lie with soft inflation numbers. Indeed, GLD bottomed shortly after the market bottomed in October when market participants concluded that inflation had finally peaked. Inflation’s peak does not equal the Fed’s inflation target; the Fed has gone to great lengths to issue these reminders. Yet, beyond day-to-day volatility, the market has overall chosen to fight the Fed’s hawkishness ever since October. Volatility is even back to levels last seen at the start of trading in 2022 despite the linger crisis in regional banking.
Where volatility is poorly positioned, GLD is well-positioned. From the looming battle over the U.S. debt ceiling to the prospect of the Fed standing down later this year to geo-political risks, there are enough reasons to stay bullish on GLD. I am back to trading around my core position. I took profits on half my call spreads last week. My remaining half is set to expire in September. I want plenty of runway for the gold-positive catalysts to work their way through the golden inflation conundrum.
Be careful out there!
Full disclosure: long GLD shares and call spread
Don’t Blame the Fed: The Fed Gives Us What We Want
Posted: March 21, 2023 Filed under: commodities, Economy, gold | Tags: CME FedWatch Tool, Fed balance sheet, Fed Fund Futures, Federal Reserve, gold, Jim Chanos, Monetary Policy, National Financial Conditions Index, NFCI, Panic of 2023, PHYS, SBNY, Signature Bank, Silicon Valley Bank, Sprott Physical Gold Trust ETV, SVB, SVB Financial Group 2 CommentsThe Fed’s risk management strategy was ostensibly designed to keep pushing rates higher until the Fed slayed the inflation dragon or something in the economy forced it to stand down, whichever came first. Unfortunately for the Fed, the dice rolled in favor of the latter. Instead of a soft landing or even a mild recession, bank failures landed on the Fed’s collective lap in the form of SVB Financial Group (SVB), the parent company of Silicon Valley Bank, and Signature Bank (SBNY). It is very easy to blame the Fed for this mess (today’s chorus is pretty emphatic on this point). However, the problems in Silicon Valley Bank (SVB), which was the strongest catalyst for the Panic of 2023, started well before the Fed belatedly decided to start tightening monetary policy. ABC News confirmed reports from the New York Times and the Wall Street Journal on the following timeline:
- Starting in 2019: The Federal Reserve warned Silicon Valley Bank about risks in the bank.
- 2021: “The Fed identified significant vulnerabilities in the bank’s containment of risk, but the bank did not rectify the weaknesses.” Ironically enough, one of the six fines issued to SVB included “a note on the bank’s failure to retain enough accessible cash for a potential downturn.”
- July, 2022: a full supervisory review revealed the bank as “deficient for governance and controls.”
- Fall 2022: the Federal Reserve of San Francisco met with “top officials at the bank to address the lack of accessible cash and the potential risks posed by rising interest rates.”
In other words, tight monetary policy was not the root problem of the bank’s problems. Tighter monetary conditions finally forced the issue of disciplining the bank. Tighter monetary policy is supposed to mop up excesses in the economy, and Silicon Valley Bank is starting to look like yet one more egregious example of the excess enabled by the prior era of easy money. It will be interesting to see whether the Fed’s review of its regulatory supervision includes claims that it lacked the authority to force SVB to change its ways.
The Fed Gives Us What We Want
Regardless, as I continue to see blame heaped on the Fed for this latest episode of financial instability, I have surprisingly adopted a more sympathetic view of the Fed’s work. The Federal Reserve has a near impossible job. It seems every major change in monetary policy sets the seeds for the next financial drama. Every financial drama raises the Fed’s prominence yet higher as a centralized economic planner, never able to return to the background of a free market. The Fed now must constantly tinker with interest rates with no clear terminal point. In particular, the economy has set up the Fed to bias towards keeping monetary policy as accommodative as possible for as long as possible. The Fed gives us what we want: policy that supports higher asset prices from stocks to real estate.
The index of financial conditions, as measured by the National Financial Conditions Index (NFCI), since the Great Financial Crisis (GFC) shows extended periods of very easy financial conditions. It is remarkable how little time the economy has been stuck with a positive index, or even a component on the positive side of danger…even in the aftermath of the economic shutdowns from the pandemic.
The Fed’s balance sheet is an even better example of how the Fed gives us what we want in the form of accommodative monetary policy. The Fed was never able to reduce its balance sheet after the GFC. The current tightening cycle barely put a dent in the Fed’s balance sheet. I have a sneaking suspicion that the Fed will never get its balance sheet back to pre-pandemic levels either. Note how the balance sheet ticked up as of last Wednesday in the wake of the rescue programs rolled out to backstop failing banks.
![Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets: Wednesday Level [RESPPANWW], retrieved from FRED, Federal Reserve Bank of St. Louis, March 21, 2023.](https://inflationwatch.files.wordpress.com/2023/03/fed-balance-sheet.png)
Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets: Wednesday Level [RESPPANWW], retrieved from FRED, Federal Reserve Bank of St. Louis, March 21, 2023.
Before the GFC, this kind of balance sheet expansion was considered unthinkable. Surely, such a growth in the balance sheet would cause dangerous inflation levels. Given the on-going duration and size of this expansion, I am guessing economic theories will slowly but surely normalize the existence of this balance sheet. Yet, the longer this largesse continues, the more the economy will depend on sustaining these high levels. Thus, the economy will remain vulnerable to instability whenever economic conditions force the Fed into tightening policy. (Recall how the previous tightening cycle moved at a snail’s pace but still eventually forced the entry of a “Plunge Protection Team” to put a floor under the stock market).
What We Want Is Not Free
In a July, 2022 interview on Bloomberg’s Odd Lots (starting at the 14:35 point), famous short-seller Jim Chanos presciently claimed (emphasis mine):
“The one thing people are not prepared for is interest rates resetting meaningfully higher…It just hasn’t happened in most investors’ lifetimes…the idea that actually interest rates are not going to be 2 or 3% for the foreseeable future is going to be hard for a lot of investors to deal with. If we go back to what I would think are more reasonable rates based on what we’re seeing in the economy…this market will not be able to handle 5 or 6% 10-year. It just won’t. So many business models that we look at are extremely low return on invested capital because capital has been so plentiful for the past 12 years.”
The subtext here is that the Fed’s bias has been to leave monetary policy as accommodative as possible for as long as possible. Deflation was the great imperative chasing the Fed into monetary corners. The response to the pandemic was the logical conclusion of this policy as the Fed decided it had the luxury to keep driving unemployment ever lower by holding rates lower for longer. The economy appeared to be in another era where liquidity and massive stimulus could be conjured up for free. The pandemic’s inflationary pulse eventually turned the tables. What we want can actually be quite costly.
Thus, the Fed finds itself in a new trap. I feel for the Fed, but I don’t blame them…we prefer easy money…and many eagerly await the Fed getting disciplined back into cooperation by the Panic of 2023. The Fed Fund futures suddenly expect a long string of rate cuts to follow peak rates in May. I sure hope inflation cooperates as well!
Source: CME FedWatch Tool as of March 21, 2023
A Golden Epilogue
Gold received a new burst of life thanks to the Panic of 2023. As soon as the Fed blinks, I expect gold to rally further. I am keeping the buy button close as we go into the next several decisions on monetary policy starting with March’s. The Sprott Physical Gold Trust ETV (PHYS) broke out to an 11-month high. Today’s 2.0% pullback from over-extended price action looks like it is setting up the next buying opportunity.
Source: TradingView.com
Be careful out there!
Full disclosure: long GLD
An Inflation Downtrend Quickly Evaporates
Posted: February 24, 2023 Filed under: Bond market, Economy | Tags: Federal Reserve, iShares 20+ Year Treasury Bond ETF, PCE, Personal Consumption Expenditures, S&P 500, SPY, technical analysis, TLT Leave a commentSome inflation analysts have enthusiastically contorted the inflation data to dismiss today’s inflation problem and/or conclude that inflation’s run came to an end months ago (since last year’s peak). One method of dismissal came in the form of a downtrend in the monthly change in the core Personal Consumption Expenditures (PCE) starting conveniently at the peak as far down as November’s relatively benign reading. (Alan Binder used a related method dividing inflation into different time periods). Suddenly, with two consecutive up months that inflation downtrend has evaporated. The mist leaves behind what essentially looks like a random walk in the land of higher for longer.
Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; February 24, 2023.
The chart above shows how the pandemic disrupted a serene post financial crisis range for monthly core PCE largely between 0.0% to 0.2%. Since PCE’s breakout two years ago (which the Fed ignored as transitory), core PCE has effectively settled into a higher range from 0.2% to 0.6%. Inflation may have indeed peaked, but it remains stubbornly high in the aggregate. The eagerly anticipated pre-pandemic serenity remains as elusive as ever.
Higher for longer inflation aligns with the Federal Reserve’s insistence on maintaining restrictive monetary policy higher for longer. The stock market may finally be catching on to the notion of higher for longer for inflation. When the core Consumer Price Index (CPI) came in hotter than expected in the previous week, the S&P 500 (SPY) wavered from intraday highs to lows and even increased the next day. Sellers took over the next 5 of 6 trading days with today’s 1.0% loss seemingly confirming a change in sentiment.
The S&P 500’s loss would have been worse except traders decided to defend support at the 200-day moving average (DMA) (the blue line above). This important trend line separates the index from more churn and a continuation of selling back down to the bear market line (20% down from the all-time high).
The bond market sniffed out the hotter inflation environment ahead of the stock market. Bond yields have steadily risen all month. For example, the iShares 20+ Year Treasury Bond ETF (TLT) is down 5.8% month-to-date (lower TLT means higher yields). The hot PCE brought an abrupt end to a 2-day relief rally in TLT.
Of course, the inflation story does not end here. The recent experience with inflation surprises suggests inflation will continue to confound the over-confident. A humbled Federal Reserve seems validated in taking a “risk management” approach to monetary policy in this haze of uncertainty. Still, if monthly core PCE takes a fresh drop next month, I am guessing a chorus will resume the inflation dismissals. If monthly core PCE continues higher from here, I will ring fresh alarm bells. I am watching the bond market’s next moves for potential clues. Moreover, I cannot wait to hear what the Federal Reserve and Chair Jerome Powell have to say about these developments in next month’s meeting!
Be careful out there!
Inflation Watch 
