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Inflation is Heating Up - What Does this Mean Going Forward?
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Someone should’ve told Biden about celebrating too early.
The irony was comical as Biden took the stage to celebrate the Inflation Reduction Act the exact same day that CPI came in showing inflation was worse than expected.
Some of the best images of the day were the banners that overlaid the aviator-clad president, the self-congratulatory headlines, and the market tanking.
The CPI print was a discouraging read for those of the view that prices are finally under control.
Although a certain White House Press Secretary will tell you, “prices have essentially been flat in our country these last two months.” This is not correct.
And the component breakdown especially matters now.
While an increasingly complex global macro and geopolitical landscape continues to evolve, inflation continues to befuddle experts.
Let’s try to understand the recent print and how to position ourselves going forward.
This week, in <5 minutes, we’ll cover the CPI Print:
By The Numbers 👉 Headline Print, Core
Components 👉 Energy, Housing, Food
What This Means For Rates 👉 At Least 75bps Next Week Now Certain
Let’s get started!
1. By The Numbers 👉 Headline Print, Core
The CPI print rose 8.3% Y/Y in August vs. the 8.1% consensus forecast, while core CPI (stripping out food & energy) rose 6.3%, vs. expectations of 6.1% and July’s figure of 5.9%.
An important component to keep in mind here is that the core component, the gray bar in the chart above, rose for the first time in six months. Of the core category, shelter, food, and medical care were the largest contributors to price growth.
The knee-jerk reaction from the market sent the NASDAQ down 5.2% on the day, while the S&P was off 4.3%
Here is a MoM and YoY (last column on the right) breakdown per the BLS that looks at individual product categories.
Now let’s dive in on the major ones and see what happened.
Under the Radar
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2. Components 👉 Energy, Housing, Food
It is officially hard to blame the price at the pumps now on inflation as we saw gas prices fall for 70 days in a row by the end of August. Opposite the case of Europe, the Energy picture in the US actually improved from the consumer side when it comes to commodities although the services side continued to inflate.
The figure is still up big time on a YoY basis as gasoline is up 26% and fuel oil is up 69%. One component of this is “the cure for high prices is high prices” as we saw demand soften on the back of the increased prices. But the largest contributing factor was the retreat in WTI from recent all time highs
Since crude accounts for more than 50% of what we pay at the pump, the energy component declines of CPI here are rather predictable.
The puzzling one here is the cost of shelter continuing to march on. The increase of 0.7% in the month contributes to the 6.2% YoY increase, despite record US Mortgage rates:
As potential home-buyers are priced out of the market, the demand for rental units has increased, pushing rents up. Homeowners, on the other hand, are staying put rather than selling their homes in a very soft market that has seen transaction volumes fall off a cliff.
What we’re seeing here is extremely stale pricing on the homefront when it comes to calculating the OER for existing homeowners because of the lack of accurate comps when calculating the OER. For my in-depth note on the housing space that I wrote a month ago, click here.
While affordability is rapidly deteriorating through higher rates, the CPI metric continues to march on, which leads me to think this will very shortly start to turn into a detractor rather than a contributor to CPI growth.
Food is probably the one that I’m most worried about. Strangled supply chains and increased input costs have been sending food prices higher consecutively month over month, and I don’t think this will end soon. As if supply chain constraints aren’t enough, we’ve experienced significant droughts as well:
At least 40% of the United States has been suffering from drought conditions for 101 consecutive weeks. Overall, this is the worst multi-year megadrought in the country in 1,200 years.
Europe is currently experiencing the worst drought that it has seen in 500 years. In some parts of central Europe, river levels have fallen so low that “hunger stones” are being revealed for the first time in centuries.
China is facing the worst drought it has ever experienced in recorded history.
This is not a discretionary item. This is a basic human necessity and everyone is going to get squeezed.
While up 11% YoY overall, grocery list items have even more sticker shock.
Before we continue, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel!
3. What This Means For Rates 👉 At Least 75bps Next Week Now Certain
So we know that inflation is coming down in some areas, but up in the core. The question is - now what?
A recession looks like a near certainty over in Europe, but the experts disagree on the verdict for the US. Some think we may achieve this mythical soft landing while others believe we are already in a recession.
While a 75bps hike for the Fed still seems to be consensus, the market is now pricing in a 18% probability of a 100bps hike. November is pricing in a 75bps hike, and December is seeing odds for a 50bps hike increase.
When it comes to a terminal Fed funds rate, the market is now pricing in 4.3% vs. 4.0% pre-CPI print. In both cases, terminal yields are largely expected around March 2023.
This means we still have quite a ways to go along our tightening path - let’s hope the Fed can get it right.
Inflation is without a doubt the most important factor in the market right now because it will dictate the path of interest rates.
Inflation is troubling because of 1) The complexity of the moving pieces, and 2) The level of uncertainty.
The market hates uncertainty.
Compared to 2020 - 2022, the prior decade had been (more or less) on autopilot with lower for longer rates providing a flood of capital into the system. But now we have a dangerous cocktail of:
China/US tensions elevated amongst deglobalization and onshoring
Russia/Ukraine war causing extreme energy infrastructure collapse in the EU
Rampant global inflation as a result of strangled supply chains and increased input costs
Global central banks pursuing tightening monetary policy, raising rates
And the unfolding events are making everything impossible to predict:
“I have been doing this 45 years and between the pandemic and the war and the crazy policy response in the US and worldwide, this is the hardest environment I have ever encountered in trying to forecast 6 - 12 months ahead.”
- Stanley Druckenmiller
The most important thing is to do the work, keep your emotions in check, extend your time horizon, and dollar-cost average through.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
What else we Grittin’ On?
Q3 CUTS. Analysts have cut estimates for Q3 earnings growth by 5.55% since June 30. They were the biggest cuts since Q2 2020.
QUANTS. Quant hedge funds bought $31 billion in global equities last week. They remain, however, broadly short.
M&A. The new 15% minimum corporate tax poses a threat to the mergers & acquisitions world. Some deals will no longer be tax-free.
REAL ESTATE. Home prices in the world's hottest real estate markets are coming down. Many are dropping rapidly.
MASA COMEBACK? Masayoshi Son's SoftBank is considering launching a third Vision Fund. No word on whether or not it will be investing in Adam Neumann's new company.
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