Markets Now See Imminent Disinflation – Forbes | CarTailz

The CPI for October came in at +0.4% M/M, much better than the consensus estimate of +0.6%, and the Y/Y read, a Fed favorite, fell to 7.7 from 8.2% %. The financial markets cheered. The tech-heavy indices, which had been hit hardest by the recent sell-off in markets, rose the most. The Nasdaq rose 7.9% on Thursday; the S&P 500 rose 5.5% and the DJIA, the least tech-heavy, lagged but was still up 3.7%. The “core” rate (excluding food and energy) increased by only 0.3%.

While this CPI and the trends within it were unexpected for the markets, it came as no surprise to us as we have always felt that markets have been overly pessimistic about the future of inflation.

· Excluding housing (+0.8%), energy (+1.8%) and food (+0.6%) (which are unlikely to repeat such levels in the near future), the rest of the index actually fell by -0.1%. There were price decreases for:

  • Medical supplies
  • financial services
  • Car rental
  • airlines
  • Delivery services (which says something about the condition of the consumer)
  • used cars
  • dress
  • furniture
  • domestic appliances

· In previous blogs, we’ve talked about the antiquated way the Department of Commerce calculates rents. The rise in rents in this CPI report was the highest since August 1990. We know that private market rents have fallen and we know that this will be reflected in next year’s CPI releases, pushing the index down is pressed.

· Energy and food prices are already high; If they just stopped rising, the Y/Y CPI, which seems to be driving the Fed, would fall to 1% by June. The table shows where the CPI Y/Y would be at monthly growth rates of 0.0%, 0.1%, 0.2% and 0.3%.

· There is a possibility that we may have negative CPI growth for a few months. That will happen when food, energy, and rent prices simply stabilize. Let’s be conservative and use the 0.2% column. By June, the CPI backwards Y/Y measure used by the media would be 2.6% and it is likely that we will be in a deep recession. Until then, it seems pretty obvious that the Fed needs to start cutting interest rates.

· As of this writing, the Fed looks set to hike rates by 50 basis points (bps) at its December meeting. Before this meeting, however, there is another employment report and another CPI report. A weak jobs report and another good November CPI might even convince them to hike just 25 basis points; and maybe that’s it for this tightening cycle.

· It looks like fixed income markets are starting to anticipate this as the 2-year T-Note yield fell -30 basis points (bps) (ie -0.3 percentage point) on Thursday, the 5-Yr fell -35 basis points, 10-year -33 basis points and 30-year -26 basis points. (Hope everyone bought treasure rooms on Wednesday!)

financial stability

One of the hallmarks of tightening cycles is that they expose the excessive leverage that often builds up when central banks have been loose for far too long before tightening. It is well known that the Fed and other major central banks have stayed far too easy (rates close to 0%) for far too long this cycle. To top it off, this particular tightening cycle was the fastest since the Volcker era (early 1980s) (see chart above). Various instabilities occur during these periods. The classic examples of this are the bankruptcies of Long-Term Capital Management (1998) and Lehmann Brothers (2008). There were others: Orange County (1994) and Penn Central (1970; nearly destroyed Goldman Sachs) come to mind. Almost all of these occurred as interest rates rose, exposing those who were over-leveraged.

In today’s world, we have recently seen the Bank of England bail out UK pension schemes that have been over-leveraged for so many years due to meager yields, and we have seen other central banks use a significant chunk of their reserves to support their currencies (Bank of England, Bank of Japan, People’s Bank of China, European Central Bank…).

Last week, the cryptocurrency market took a tumble as a major crypto platform, FTX, suffered the equivalent of a bank run and declared bankruptcy. Its CEO and founder, Sam Bankman-Fried, saw his $23 billion net worth disappear almost overnight. We also saw the Bank of Korea intervene in the FX market (FX
fx
) markets to protect the value of the Korean won. It added $36 billion in commercial paper and corporate bonds to its portfolio (quantitative easing) to curb interest rate hikes there. All of this is happening because the US Federal Reserve appears to have tightened too tightly and, worse, continues to tell the world that rate hikes are yet to come.

The Fed employs more than 300 economists, and these professionals produce many relevant studies. One of these reports is called the Financial Stability Report and is produced every six months. The latest report that has just been released contains a long list of financial stability concerns. Among them:

  • High vacancy rates in commercial real estate
  • Margin calls due to rising interest rates
  • Arrears on subprime consumer debt
  • Liquidity in the bond market
  • Leverage in US shadow banks
  • China’s real estate market
  • Financial Distress of US Consumers/Businesses

This is no small list of concerns. But Fed chairmen seem indifferent, despite these problems coming from their own staff. We have pointed out in previous blogs that bond market liquidity was an issue as some large treasury blocks could not be sold without breaking them into smaller chunks. The mortgage-backed securities (MBS) market has also shown some liquidity problems recently. The latter two could be partly due to the reduction in the Fed’s balance sheet ($100bn/month for Treasuries and MBS).

Other

  • There are other data points that concern us. The chart shows that banks are reporting much weaker demand for mortgages, a topic we have been discussing for a few months. Also note that auto loans are weaker (and we note that used car prices have fallen four straight months) and commercial loans have just turned negative. Unsurprisingly, demand for credit cards has increased as consumers seek credit to sustain their standard of living.
  • We are noticing that the pressure on the supply chain has eased dramatically and this is now reflected in the CPI. The first chart we showed in our last blog is the poster child for supply chain issues, ie the number of ships waiting to be unloaded in California ports. From a record high in February to a recent record low.

The second chart shows the cost of shipping goods across the Pacific. Again from a record high earlier in the year to a near normal level as of this writing.

The third chart shows ISM manufacturing data (supplier delays and prices), another indication that disinflation is at hand in our immediate future.

Final Thoughts

Every indicator we watch tells us that the recession has started. This includes the latest GDP and employment reports, which we have discussed extensively in our last two blogs. The Fed continues its hawkish rhetoric, despite all the historical indicators (yield curve inversion, leading economic indicators, internal Fed surveys) telling them that a recession is likely already here. This Fed seems unaware of the havoc its policies have wreaked on the rest of the world (liquidity issues, currency values, etc.) and what the future consequences might be if this world decides that anything other than the dollar should be the world’s reserve Currency.

There was a run on a crypto exchange last week, resulting in that exchange filing for bankruptcy protection. If interest rates keep going up, expect more things to break. All this despite the undeniable evidence that inflation’s backbone has already been broken. Too bad the Fed is looking at inflation through the rear view mirror of Y/Y comparisons instead of looking at the latest monthly data. It’s a shame they don’t analyze the incoming data like GDP or employment numbers to uncover the real underlying trends.

In just a few months, however, the incoming data will be so overwhelming (poor jobs, sluggish economic growth, melting inflation) that it will have to ‘pause’ and then ‘pivot’. We suspect this will be before mid-2023.

(Joshua Barone contributed to this blog)

Leave a Comment