By Michael Every of Rabobank
A stonking US CPI number
You could hear the champagne corks fly wherever you were yesterday. After all, there was “zero US inflation” in July, as some put it.
And that came after zero US recession, as some also put it, despite two consecutive quarters of negative GDP growth. And after a red-hot labour market report. And EIA energy data showing gasoline usage apparently well below 2020 levels despite all this non-recession and jobs boom, and even as refineries are working at incredibly high capacity levels, diesel stocks are low, and exports are also down. These are all numbers/claims worthy of champagne. Yet they make little sense taken together.
Until you recall US midterm elections are coming up. Then you wonder if it is just coincidence, bad/Covid number-crunching, or ‘convenient’ in a way we pretend DM data can’t be, because otherwise we would be EM, and we don’t like to imagine we could be, because: we have higher incomes – as millions struggle to put bread on the table or keep the lights on; ‘regulations’; ‘rule of law’; absolutely no corruption; a completely unbiased media only interested in the truth; no politicised judges or civil servants; no business sectors close to politicians; no politicians with tenuous grasps of reality; no back-stage lobbyists; no interest groups; no powerful shady forces; no issues over electoral legitimacy. None of that applies to us!
(As they used to say back in the Soviet bloc, “We pretend to work, they pretend to pay us.” Nowadays, it’s perhaps, “They pretend it’s real data, we pretend to trade it.”)
Of course inflation was actually up 8.5% y-o-y, even if it was flat m-o-m, which was better than expected, and on a m-o-m and y-o-y core basis too. It may actually have peaked for now.
However, food prices soared; shelter (or rather OER) too; and only falling energy kept inflation “zero” in the month. Moreover, there seems little chance US inflation goes back to 2% anytime soon. In particular, the Strategic Petroleum Reserve (SPR), whose barrels are now all round the world, temporarily depressing prices, needs to be refilled. More broadly, whisper it, but the structure of the global economy now is not the same as in 2019! (Europe faces recession and inflation; and even the PBOC’s quarterly inflation report yesterday warned of structural inflation risks.) Worse, nobody but Wall Street wants to go back to 2019 anyway. Nobody wants a return to low nominal pay, low demand, and low inflation.
True, nobody wants low (or negative) real pay, low demand, and high inflation either.
But those are our two choices – and only one of them offers central banks the change of retaining even a shred of their tattered credibility. (And, arguably, perhaps of the West retaining DM status.)
Regardless, the market decided “TRANSITORY!” and “FED PIVOT!” (and “rich people in EM live very well!”) were the buzzwords of the day, despite every smart voice I know having already expected a weaker than expected CPI print. What was priced in is now even more priced in.
And yet there is still no guarantee it will be delivered. The very best the Fed may do is go ‘just’ 50bps not 75bps in September – but unless oil prices can keep falling like they just have (“Empty the SPR completely!”), we are surely still far from said pivot.
Indeed, two Fed members came out after CPI to underline what all of them were saying before it – that they are not going to change direction; that they are going to keep hiking; that they are not impressed by just one positive number. (Where headline inflation is 8.5% and core 5.9%.)
There is a geopolitical angle to this that I keep banging on about, and most market commentary keeps ignoring because they don’t understand or won’t talk about geopolitics. Higher Fed Funds would push commodities down, punishing Russia. And innocent bystanders too – who would then need to turn to Fed swaplines, with strings attached. Win-win. On top of that, Adam Tooze underlines in his latest missive that higher Fed Funds also places increased pressure on China, whose huge trade surpluses are perhaps being matched by massive outflows of foreign capital, a de facto financial decoupling. (Which is perhaps partly why the PBOC is saying what it is.) That money is going to go back into the West, or into ‘friend-shoring’. Quite the way to keep the dollar top dog vs. any new world order whipper-snappers. Win-win-win.
Yet even just on traditional economy/market metrics we can see why the Fed needs to show staying power. Indeed, we got a sniff of what will happen if it pivots when we saw: Bitcoin up; yields plunge; the dollar dip; oil jump at first, then sink, then end up even higher again; stocks up; and stonks fly.
Indeed, it was literally a stonking CPI number that screamed “SPECULATE, DON”T ACCUMULATE!”
And that is exactly what you want to hear in a high-inflation economy leading a geopolitical economic war, a hush-hush Cold War, and a nasty hot war, and needing to expensively prepare to prevent risks of others: note the flood of orders for military equipment coming into the US from all over the world, on top of its own needs, and the massive waiting time that is required. After all, which previous Great Power didn’t fare well by forcing precious resources into speculative frippery and spiv-ery rather than productive assets tied to technology, commodities, and its military?!
In short, are the Fed really going to pivot to help stonks and oil go up? Or are they going to lift rates higher, and stay higher, to try to repress inflation, and remain top dog globally, despite the collateral damage?
To be honest, this places me in a very uncomfortable position. I haven’t agreed with anything the Fed has said or done in so long that I can’t remember when I last did. Yet here I am actually believing them – even while acknowledging that they still don’t know what they are doing.
Maybe I just want to believe that when push comes to shove, at least some of our institutions are still fit for DM status because of the geopolitical implications if they aren’t. Yet I must share that some of the people in markets I hold in highest regard think soft data, a pivot, stonks-a-go-go, and a shift to EM status loom.