by Bryan Perry

August 30, 2022

As inflationary pressures were building in mid-2021, Fed Chair Jerome Powell maintained the Fed’s stated belief that inflationary pressures were “transitory.” At a Senate Banking Committee hearing in late November 2021, Powell said he would stop using that word, adding that he expected high inflation to run to the middle of 2022, vowing that the Fed would not sit idly by and let inflation continue to climb higher. “We will use our tools to make sure that higher inflation does not become entrenched,” he promised.

Oddly enough, this late-2021 admission that the Fed was wrong and would act did not result in any fast actions. Instead, the Fed kept Quantitative Easing (QE) in full force until March 2022 as inflation kept rising. Powell said that he “didn’t want to shock the market.” Well, he just delayed the shock.

Powell’s speech at Jackson Hole last Friday did shock the market. He sounded as if he was mad at the world and how history will remember him, as a “Johnny Come Lately” Fed Chairman that was tardy in addressing inflation, followed by a monetary policy that will overshoot when inflation is already falling.

The Fed’s favorite inflation yardstick, the Personal Consumption Expenditures Price Index (PCE), showed a month-over-month increase of just 0.2% in July, far short of the predicted 0.6%. Personal spending rose just 0.1% versus a consensus +0.4%, following a downwardly revised +1.0% increase from +1.1% in June. The PCE Price Index declined -0.1% month-over-month versus a consensus of +0.1%, which left it up 6.3% year-over-year vs 6.8% in June. This is a clear move lower – in the right direction.

The core PCE Price Index, which excludes food and energy, increased +0.1% month-over-month versus a consensus +0.3%, which left it up +4.6% year-over-year versus +4.8% in June, also moving in the right direction: lower. Powell made no mention of these improving facts in his speech, which I thought odd.

Disinflation is underway and rather than acknowledge the good news that inflation has probably peaked, Powell talked of household and business pain, and raising rates to fight inflation “until the job is done.”

Core Inflation Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Gas prices have already retreated by 23% from their June high, and prices for crude oil, wheat, corn, soybeans, cattle, lean hogs, sugar, cocoa, orange juice and lumber are all trading off their 2022 highs, setting the course for further declines in headline inflation data for August (to be released September 13).

The only commodities hitting new highs are natural gas and coffee. There is a famous saying in the commodity market that “the cure for high prices is high prices.” Translated, this means that people tend to buy less at higher prices, causing supply backlogs and lower prices – a self-correcting mechanism.

Retail Price Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Institutions see lower inflation ahead. The institutional smart money that trades in the inflation swaps market sees lower inflation. (An inflation swap is a transaction where one party transfers inflation risk to a counterparty in exchange for a fixed payment.) Swaps are used by professional traders and fund managers to hedge inflation risk. These inflation swaps by professionals can provide a pretty accurate estimation of what the pros consider the break-even inflation rate. What is it now? The one-year forward Secured Overnight Financing Rate (SOFR) rate is now 2.7%, where it has been pegged since mid-June.

After a great summer rally, the markets suddenly turned nervous just because Jerome Powell implied that inflation will be around for a long time, but the swaps market is trading with a definite idea of a lower level of inflation for the next year. Powell noted that the Fed policy will pivot when the pace of inflation is on a trajectory to be under control, but after losing so much credibility for standing his ground with “transitory inflation” too long, Fed governors are not about to make any new predictions.

As Fundstrat’s Tom Lee so insightfully noted last Friday, the drivers for rising or accelerating inflation have essentially evaporated. Housing is in a significant downturn as inventories are approaching levels not seen since the great financial crisis of 2008. High demand durable goods, like cars and furniture, that were recently bid higher due to supply chain issues, are now seeing lower demand, even as prices fall.

Monthly Supply of New Houses Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

On the topic of wages, Lee cites high-frequency measures, such as job openings from Labs, being down more than 40%. Wage growth doesn’t have to get down to zero to meet the Fed’s inflation target. It has to fall just 1% to 1.5% from its current 5% to be consistent with actual overall inflation of 2%. Recent monthly job growth is a result of workers taking on second or third jobs. Single job-holder growth has actually declined in the past two months. It’s not as great a labor market as it is touted to be.

The stock market ultimately takes its cue from the bond market, where the 10-year Treasury rate closed at 3.04% last Friday in very stable trading. For the Treasury market to end a wild day flat, after an ultra-hawkish speech by Powell, is a positive tell. Another key data point is that consumer expectations of future inflation are falling, and, for the third month in a row, the University of Michigan surveys show consumers see lower inflation for the next one and five years. I’m not being dismissive of the risk of global macro events, but the S&P had already fallen 24% from peak to trough by mid-June, which likely priced in the current technical recession, as evidenced by two quarters of negative GDP in the first half.

The current high prices for homes and durable goods are arguably just going through an adjustment from Covid-inflicted shortages, implying a “soft landing” that runs counter to the consensus that overwhelmed the market last Friday. This trend should also start showing up in the used car market and travel industry, where prices have been very elevated, and are big components in the CPI data.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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