Inflation Spikes: Market Yawns
Another week, another hot inflation data point. According to the government report out this week, May headline CPI rose 5% from a year earlier. Economists surveyed by Dow Jones had been expecting a gain of 4.7%. On a monthly basis, headline CPI increased 0.6% versus estimates for a 0.5% increase. The core inflation measure that omits volatile food and energy prices, considered by many economists to be a more accurate gauge of underlying inflation, also shot up 0.7% in May. The 12-month core rate climbed to 3.8%, a number representing a 29-year high. The 3.8% reading outpaced the Dow Jones estimate of a 3.5% 12-month increase.
The headline CPI numbers for the last three months now stand at 0.6% in May, 0.8% in April, and 0.6% in March. These are the three highest month-over-month readings since 2009, and, combined, for some perspective, would project an annualized reading of 8.1%. As has been chronicled at great length, the Fed does not see anything near an 8.1% annualized inflation rate materializing, but rather anticipates inflation moderating for the remainder of the year. Markets largely agree, and greeted the news with a yawn. For the most part, investors have bought into the Fed’s argument that inflation will be “transitory.”
What the CPI numbers are really telling us is somewhat in question. The data is a bit obscure when comparing the readings to past numbers. As a Forbes article points out, the government has changed the way it calculates inflation more than 20 times over the past 30 years. If CPI were calculated by past standard calculations, the current inflation numbers would be significantly higher. In the current number, the most obvious area of understated price pressure comes from housing.
The homeownership component, called “Owners’ equivalent rent of residences” is weighed at 23.8% of overall May CPI. OER was up 0.3% in May and only 2.1% for the 12-month period. The Case-Shiller Home Price Index over the past 12 months, on the other hand, was up just a little bit more, at 13.2%. That is the highest 12-month Case-Shiller reading since 2005. As a ZeroHedge article points out, the OER number is “based on surveys of homeowners’ estimates of how much their home would rent for. It is a measure of rent, as guessed by the homeowner.”
Nevertheless, despite actual CPI numbers or the details of CPI measurement, US and global Central Bank officials and G7 politicians seem committedly unconcerned. The commonly held stance seems to be the need for ongoing economic support without concern for inflation. The US Fed has repeatedly made that clear, and on Thursday ECB President Christine Lagarde added her two (euro) cents. Speaking in Germany, Lagarde spoke to the importance of “preserving favorable financing conditions,” while adding that, “Headline inflation is expected to remain below our aim over the projection horizon.”
In further confirmation that global political leaders show no signs of constraining policy decisions in light of inflation concerns; a Friday Reuter’s update from the G7 meeting in England, citing a source familiar with the discussions, reports “broad agreement about the need to continue supporting their economies with fiscal stimulus….” According to the source, “the backing for more stimulus was shared by all leaders, including Angela Merkel of Germany….” In recent history, Germany has been reluctant to pursue heavy borrow and spend policies, but it has relaxed that position in consideration of the COVID-19 crisis.
The Reuters’ report continued, “There was broad consensus across the table on continued support for fiscal expansion at this stage,” adding that, “Biden, British Prime Minister Boris Johnson, and Italy’s Mario Draghi expressed particular support.” So, in the face of still more hotter-than-expected inflation data, policymakers are all-in on a high-stakes bet of transitory inflation. The decisions made in the context of that stance may have serious longer-term ramifications.
On the other side of the transitory argument, Sal Guatieri, senior economist at BMO Capital Markets, added, “You get the message, in large font: the peppy rollout of stimulus and vaccines is causing U.S. demand to rebound much faster than supply…. This is creating many unpleasant side effects, like inflation…just a few quarters after the economy’s collapse instead of the usual several years for imbalances to emerge after a recession. The writing is on the wall: The Fed’s temporary-inflation mantra is sounding more dated by the week.”
Also this week, not exactly in lockstep with the transitory narrative, Deutsche Bank warned that “inflation is about to explode.” They see this “leaving global economies sitting on a time bomb,” and go on to predict, “policymakers will face the most challenging years since the Volcker/Reagan period in the 1980s.” Meanwhile, Bank of America is now also of the mind that “the Fed is wrong,” and sees the US facing an unprecedented period of “far higher, non-transitory inflation.”
In energy market news, Bloomberg reported on Wednesday that China is considering imposing some price controls. The report highlighted a potential cap on the price of thermal coal as the country struggles to contain high energy costs ahead of peak demand over the summer. Meanwhile, oil prices reached fresh multi-year highs on Friday, closing out a third straight week of gains on an improved outlook for worldwide demand as rising COVID-19 vaccination rates help lift pandemic curbs. The International Energy Agency (IEA) said in its monthly report that the Organization of the Petroleum Exporting Countries and allies (OPEC+), would need to boost output to meet demand that is set to recover to pre-pandemic levels by the end of 2022. The IEA said, “OPEC+ needs to open the taps to keep the world oil markets adequately supplied….”
ANZ Research noted this week that data showing road traffic returning to pre-COVID-19 levels faster than expected in North America and most of Europe was” encouraging…” and continued that “Even the jet fuel market is showing signs of improvement, with flights in Europe rising 17% over the past two weeks….” These strong demand fundamentals in the oil patch at the same time that OPEC+ has reined in production are applying pressure toward higher prices. In an indication of future supply, U.S. oil rig count increased by six to 365 this week, to their highest since April 2020, energy services firm Baker Hughes Co said in its weekly report. This was the biggest weekly increase of oil rigs in a month.
As for weekly performance: The S&P 500 was up 0.41%. Gold was down 0.66%. Silver was up 0.90%. Platinum was down 1.14%, while palladium was down 2.16% on the week. The HUI gold miners index was off 1.86%. The IFRA iShares U.S. Infrastructure ETF was up 0.55%. Energy commodities were higher on the week. Oil rallied 1.84%, while natural gas prices were up 6.55%. The CRB Commodity Index was higher, up 0.93%. Copper was little changed, up 0.15%. The Dow Jones U.S. Real Estate Index ended the week higher by 2.11%, while the Dow Jones Utility Average Index was up 1.34%. The dollar was up on the week by 0.47%. The yield on the 10-year Treasury dropped 9 bps to 1.47%.
Best Regards,
David McAlvany
Chief Executive Officer
MWM LLC
