Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. And sign up to receive notice when my book is published! The title of the book is What’s Wrong with Money?: The Biggest Bubble of All – and How to Invest with it in Mind, and if you would like to be on the notification list to receive an email when the book is published, simply send an email to WWWM@enduringinvestments.com.
- core CPI+0.13%, softer than expected. Core y/y rose from 1.77% to 1.80% due to soft year-ago comparison.
- Next month we drop off an 0.05%, so we will almost surely get a core uptick. Surprising we haven’t yet. Waiting for breakdn.
- Both primary rents and owners’ equiv accelerated slightly, Which means core EX HOUSING was actually slightly down m/m
- core services rose to 2.6% (mostly on housing); core goods fell to -0.5% from -0.4% y/y. Same story overall.
- Apparel accelerated to -1.64% from -1.85% y/y. Story for years in apparel was deflation; in 2011-12 prices rose>>
- >>and looked like return to pre-90s rate of rise. Then it flattened off, and has been declining again.
- Apparel could well be a dollar story now – it’s almost all made overseas, almost no domestic competition so dollar matters.
- our proxy for core commodities is apparel + cars + med care commodities. all 3 decelerated. Cars went from +0.5% to 0.0% y/y.
- sorry, Apparel actually ACCELERATED to -1.6% from -1.9%, but still negative.
- airfares not really a story. -5.6% y/y vs -5.2% y/y. The NSA number dropped but it always drops in late summer. [Ed note: see chart below]
- airfares was -8.5%, but it was -8.1% last july, -2.9% in 2013, -2.6% in 2012…no story there. didn’t affect core meaningfully.
- Primary rents 3.56% from 3.53%. OEW 3.00% from 2.95%. Both will continue to rise.
- Lodging away from home also rebounded to 2.9% y/y after a one-off plunge to 0.8% y/y last month. Household energy of course down.
- Transportation accelerated (-6.6% y/y vs -6.9%) on small motor fuel recovery. btw, airline fares are only 0.7% of CPI, so 0.9% of core.
- Med Care: goods were dn (drugs 3.2% vs 3.4%,equipment -0.9% vs 0.0%) but prof services up (2.1% vs 1.8%),hospital svcs dn (3.2% vs 3.5%)
- Health insurance only +0.9% y/y vs 0.7%, but more expenditures out-of-pocket under the ACA so higher infl for those categories hurts.
- Median (due out later) might only be +0.1% this month. I have it cuffed at 0.15% but I don’t seasonally-adjust the housing sub-components.
- Last yr Median was +0.17% m/m, so best guess is it roughly holds steady at 2.3%.
- I don’t see how the Fed embarks on a meaningful tightening in Sep, with global economy weaker than it has been in a couple yrs.
- Median inflation and growth plenty strong enough to “normalize” rates but that’s not a new story.
- I’ve been saying they should tighten for a few years but not sure why they would NOW if they didn’t in 2011.
- But Fed doesn’t use common sense or monetarist models.It’s all DSGE;who knows what those models are saying?Depends how they calibrated.
- FWIW our OER models diverge here. Our nominal model says pressures on core start to ebb in a few mo; our real model predicts more rise.
- I like the real model as it makes mose sense…but it’s not tested in a real upswing.
- US #Inflation mkt pricing: 2015 0.8%;2016 0.7%;then 1.6%, 1.7%, 1.8%, 1.9%, 2.0%, 2.1%, 2.2%, 2.3%, & 2025:2.2%.
- …so inflation market doesn’t see inflation at the Fed’s target (about 2.2% on CPI vs 2.0% on PCE) until 2023.
- The market is not CORRECT about that, but another reason the Fed can defer tightening if they want to. And they have always wanted to.
First, let’s start with the airfares chart. One of the early headlines was that airfares plunged by the most since some long-ago year, which held down core. Well, here is the chart of airfares, non-seasonally adjusted. You tell me whether this is unusual to have airfares fall in July.
Because this is part of a normal seasonal pattern, the year-on-year figure was only slightly lower, as I note above. And airfares are a tiny part of CPI, less than 1% of the core. This is not a story.
More important will be the median CPI. This is a much better measure of the central tendency of prices than headline or core, both of which (as averages) can be skewed by a few categories having outsized moves. Median inflation has been ticking higher (see chart below) but will probably go sideways this month.
Finally, the most important chart. There are lots of ways to model housing. If you model rents as lagged versions of the FHFA Home Price Index, or Existing Home Sales median prices, then you get one model and that model suggests that rents should begin to moderate over the next 6-12 months. Not that they will decelerate markedly, but that they will stop accelerating and therefore stop being the driving force pushing core CPI higher. But if you use those models, you have to recognize that you are calibrating over a period of very slow inflation, so that you are effectively ignoring the knock-on effect of higher inflation on rents. That is, if core inflation is around 2% and rents are 3%, then if core inflation rises to 5% you wouldn’t expect rents to be at 3%. So, you need to use a model that recognizes the interrelationship between these variables. And that sort of model implies that rents will continue to climb. Both models of Owners’ Equivalent Rent are shown in the chart below. I prefer the “real” model to the “nom” model, but we don’t know the right answer yet.
Even if OER moderates it doesn’t mean that CPI will stop rising; it just means that the story will stop being all about rents. Core goods still have a long ways to go to normalize, and that might be the next story. But for now, I am still focused on rents.
As I said, I really don’t see how the Fed can think about hiking rates in September based on the data we have seen recently. Yes, inflation is on the border of being an issue, but that has been true for a long time. In 2011, there was plenty of growth and while high rates would not have been warranted, it is hard to argue that normal rates were not called for. And yet, we got QE and more QE. This will end up being the biggest central bank error in decades, regardless of what the Fed does in September. I doubt they will hike, and if they do then it won’t be a long series of hikes. This is still a very dovish central bank, and they will get skittish very quickly if markets balk at more expensive money – which, of course, they are wont to do.
Below is a summary of my post-CPI tweets. ou can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.
- Core CPI prints +0.145…just misses printing +0.2, which will make it seem weak. We will see the breakdown.
- y/y core goes to 1.73% from 1.81%. A downtick there was very likely because we were dropping off +0.23%
- This decreases odds of Sept Fed hike (I didn’t think likely anyway) but remember we have a couple more cpi prints so don’t exaggerate.
- Core goods (-0.3% from -0.2%) and core services (2.4% from 2.5%) both declined. Again, some of that is base effects.
- fwiw, next few months we drop off from core CPI: +0.137%, +0.098%, +0.052%, and +0.145%. So y/y core will be higher in a few months.
- INteresting was housing declined to 1.9% from 2.2% y/y. But it was all Lodging away from home: 0.96% from 5.1% y/y!
- Gotta tell you I am traveling now and that reminds you the difference between rate and level. Hotels are EXPENSIVE!
- Owners’ Equiv Rent +2.79% from 2.77%. Primary Rents 3.47% unch. So the main housing action is still up. And should continue.
- Remember the number we care about is actually Median CPI, a couple hours from now. That should stay 0.2 and around 2.2% y/y.
- At root, this isn’t a very exciting CPI figure. It helps the doves, but that help will be short-lived. Internals didn’t move much tho.
The last remark sums it up. While the movement in Lodging Away from Home made it briefly look like there was some weakness in housing, I probably would have dismissed that anyway. There’s simply too much momentum in housing prices for there to be anything other than accelerating inflation in that sector. We have a long way to go, I think, before we have any topping in housing inflation.
But overall, this was a fairly boring figure. While the year-on-year core CPI print declined, that was due as I mentioned to base effects: dropping off a curiously strong number from last year. (That said, this month’s core CPI definitely calms things a bit after last month’s upward surprise). However, the next few base effect changes will push y/y core CPI higher. While today’s data will be welcomed by the doves, by the time of the September meeting the momentum in core inflation will be evident and median inflation is likely to be heading higher as well.
Note that I don’t think the Fed tightens in September even with a core CPI at 2% or above, but the bond market will get very scared about that between now and then. Could be some rough sledding for fixed income later in the summer. But not for now!
Here is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.
- CPI Day! Exciting. The y/y for core will “drop off” +0.20% m/m from last yr, so to get core to 1.9% y/y takes +0.29 m/m this yr.
- Consensus looks for a downtick in core to 1.7% y/y (rounding down) instead of the rounded-up 1.8% (actually 1.754%) last mo.
- oohoooooo! Core +0.3% m/m. y/y stays at 1.8%. Checking rounding.
- +0.256% m/m on core, so the 0.3% is mostly shock value. But y/y goes to 1.81%, no round-assist needed.
- Headline was in line with expectations, -0.2% y/y. Big sigh of relief from dealers holding TIPS inventory left from the auction.
- Core ex-shelter was +0.24%, biggest rise since Jan 2013. That’s important.
- This really helps my speaking engagement next mo – a debate between pro & con inflation positions at Global Fixed Income Institute. :-)
- More analysis coming. But Excel really hates it when you focus on another program while a big sheet is calculating…
- It’s still core services doing all the heavy lifting. Core goods was -0.2% y/y (unch) while core services rose to 2.5% y/y.
- Core services has been 2.4%-2.5% since August.
- Owners’ Equivalent Rent rose to 2.77% y/y, highest since…well, a long time.
- Thanks Excel for giving me my data back. As I said, OER was 2.77%, up from 2.69%. Primary rents frll to 3.47% from 3.53%.
- Housing as a whole went to 2.20% y/y from 1.93%, which is huge. Some of that was household energy but ex-energy shelter was 2.67 vs 2.56
- Or housing ex-shelter, ex-energy was 1.14% from 0.67%. Seems I am drilling a bit deep but getting housing right is very important.
- Medical Care +2.91% from 2.46%. Big jump, but mostly repaying the inexplicable dip from Q1. Lot of this is new O’care seasonality.
- Median is a bit of a wildcard this month. Looks like median category will be OER (South Urban), so it will depend on seasonal adj.
- But best guess for median has been 0.2% for a while. Underlying inflation is and has been 2.0%-2.4% since 2011.
- And reminder: it’s median that matters. Core will continue to converge upwards to it, (and I think median will go higher.)
- None of this changes the Fed. They’re not going to hike rates for a long while. Growth is too weak and that’s all they care about.
- For all the noise about the dual mandate, the Fed acts as if it only has one mandate: employment (which they can’t do anything about).
- The next few monthly core figures to drop off are 0.23%, 0.14%, 0.10%, and 0.05%.
- So, if we keep printing 0.22% on core, on the day of the Sep FOMC meeting core CPI will be 2.2% y/y, putting core PCE basically at tgt.
- I think this is why FOMC doves have been musing about “symmetrical misses” and letting infl scoot a little higher.
- US #Inflation mkt pricing: 2015 1.1%;2016 1.8%;then 1.8%, 2.0%, 2.0%, 2.1%, 2.2%, 2.3%, 2.4%, 2.5%, & 2025:2.4%.
- For the record, that is the highest m/m print in core CPI since January 2008. It hasn’t printed a pure 0.3% or above since 2006.
There is no doubt that this is a stronger inflation print than the market expected. Although the 0.3% print was due to rounding (the first such print, though, since January 2013), the month/month core increase hasn’t been above 0.26% since January 2008 and it has been nearly a decade since 0.3% prints weren’t an oddity (see chart, source Bloomberg).
You can think of the CPI as being four roughly-equal pieces: Core goods, Core services ex-rents, Rents, and Food & Energy. Obviously, the first three represent Core CPI. The breakdown (source: BLS and Enduring Investments calculations) is shown below.
Note that in the tweet-stream, I referred to core services being 2.4%-2.5% since August. With the chart above, you can see that this was because both pieces were pretty flat, but that the tame performance overall of core services was because services outside of rents was declining while rents were rising. But core services ex-rents appear to have flattened out, while housing indicators suggest higher rents are still ahead (Owners’ Equivalent Rent, the bigger piece, went to 2.77%, the highest since January 2008). Core goods, too, look to have flattened out and have probably bottomed.
So the basic story is getting simpler. Housing inflation continues apace, and the moderating effects on consumers’ pocketbooks (one-time medical care effects, e.g., which are now being erased with big premium hikes) are ebbing. This merely puts Core on a course to re-converge with Median. If core inflation were to stop when it got to median, the Fed would be very happy. The chart below (Source: Bloomberg) supports the statement I made above, that median inflation has been between 2% and 2.4% since 2011. Incidentally, the chart is through March, but Median CPI was just released as I type this, at 2.2% y/y again.
But that gentle convergence at the Fed target won’t happen. Unless the Federal Reserve acts rapidly and decisively, not to raise rates but to remove excess reserves from the banking system (and indeed, to keep rates and thereby velocity low while doing so, a mean trick indeed), inflation has but one way to go. Up. And there appears little risk that the Fed will act decisively in a hawkish fashion.
Yesterday, Chicago Fed President Charles Evans gave a speech in which he said that he probably leaned towards making the first tightening early next year, as there is “no compelling reason for us to be in a hurry to tighten financial conditions.” The Fed, he said, probably shouldn’t raise rates until there’s a “greater confidence” that inflation one-to-two years ahead will be at or above 2%. This isn’t a surprising view, as Evans is the progenitor of the “Evans Rule” that says rates should stay near zero until unemployment has fallen below 6.5% (it has) or inflation has risen above 2.5%. Yes, those bounds have been walked about; in particular the 6.5% unemployment rate is obviously no longer binding (he sees the “natural rate” as being 5% again). But the very fact that he promoted a rule that set restraints on a mere return to normal policy means that he is a dove, through and through. So, it should not be surprising that he isn’t in a hurry to tighten.
What I found amusing is the sop he threw to the bears. Fed speakers often try to do the “on the one hand, on the other hand” maneuver, but in Evans’ case his heart clearly isn’t in it. He said that “you could imagine a case being made for a rate increase in June.” Notice that he doesn’t say he could imagine a case being made! I am also unclear about which June he means. Does he mean…
|(thru Apr)||(thru May)|
|Q1 GDP||Q2 GDP||Median CPI||M2 growth|
|June 2015?||0.2%||1.0% (e)||2.2%||5.4%|
I am not sure exactly what he thinks those darn hawks are looking at, but it seems to me the case for tightening in June is getting worse every year.
Eagle-eyed readers will notice that I didn’t include the Unemployment Rate in the table above. That particular metric has been improving each year, but we know that the labor situation tends to lag the economic situation. The Unemployment Rate is a big political football, but it isn’t particularly useful for policy unless you believe in the concept of a “natural rate” with respect to accelerating unemployment in the overall economy. I don’t: low unemployment tends to increase wages, but has no discernible effect on consumer inflation. Moreover, it appears that the “natural rate” shifts quite a bit over time (6.5% down to 5% in Evans’ formulation, in only a few years’ time), making it look to me like a fairly useless concept.
Yes, of course it makes it more difficult politically to tighten when people are out of work, but since monetary policy is quite useful for affecting prices and not particularly useful for affecting growth, this should be a secondary effect at best. The Fed simply can’t help the unemployed worker, except by holding down inflation for him. In the real world, of course, the Fed Chair is not going to countenance an uptick in rates when unemployment is above 5% or so.
Let me be clear: I think the Fed ought to have tightened in 2012, 2013, or 2014, and they ought to tighten now. I don’t necessarily mean they should guide rates higher, but they should reduce the size of the mountain of reserves via any means a their disposal. But if you are going to argue one year over another year, I think it is hardest to argue that now is the time unless you are merely being guided by the old James Carville adage that the best time to plant a tree was twenty years ago, but the second-best time is right now.
One thing that Evans said that quickens my heart, as an inflation-watcher, is that the Fed “ought to allow” a chance that inflation overshoots 2% that is symmetrical to its chance of falling below it. While he is quintessentially unclear about how he would establish these probabilities – as I have just shown, he seems blissfully unaware that consumer price inflation is already above 2% – the mere fact of treating the costs of inflation misses as symmetrical is dangerous territory. The costs are not symmetrical. The costs of an inflation rate around 0% are very low; some frictions, perhaps, created by wage “stickiness” (even this possibility hasn’t been conclusively established until inflation gets convincingly below zero). The costs of an inflation rate of 4% are much higher, since inflation has historically had long “tails.” That is, once inflation goes up a little, it not infrequently rises a lot. Over the last 100 years, if you take the set of all year-on-year inflation rates above 4%, you find that about one-third of them are also above 10%. This means the costs of a loss of inflation vigilance is must greater than the costs of a loss of deflation vigilance.
Below you can find a recap and extension of my post-CPI tweets. You can follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.
- core CPI +0.157%, so it just barely rounded to +0.2%. Still an upside surprise. Y/Y rose to 1.69%, rounding to 1.7%.
- y/y headline now +0.0%. It will probably still dip back negative until the gasoline crash is done, but this messes up the “deflation meme”
- (Although the deflation meme was always a crock since core is 1.7% and rising, and median is higher).
- Core ex-housing +0.78%. Still weak.
- Core services +2.5%. Core goods -0.5%, which is actually a mild acceleration. So the rise in core actually came from the goods side.
- Accelerating major cats: Apparel, Transp. Decel: Food/Bev, Housing, Med care, Recreation, Other. Unch: Educ/Comm. But lots of asterisks.
- Shelter component of housing rose back to 3% (2.98%) y/y; was just fuels & utilities dragging down housing.
- Primary rents: +3.54% y/y, a new high. Owners’ Equiv Rent: 2.69%, just off the highs.
- In Medical Care, Medicinal Drugs 4.13% from 4.16%, but pro services +1.47 from +1.71 and hospital services 3.28% from 4.08%.
- In Education and Communication: Education decelerated to 3.5% from 3.7%; Communication accel to -2.2% from -2.3%.
- 10y breakevens +3bps. Funny how mild surprises (Fed, CPI) just run roughshod over the shorts who are convinced deflation is destiny.
- No big $ reaction. FX guys can’t decide if CPI bullish (Fed maybe changes mind and goes hawkish!) or bearish (inflation hurts curncy).
- Here’s my take: Fed isn’t going to be hawkish. Maybe ever. So this should be a negative for the USD.
This CPI report was a smidge strong, but just a smidge. The market was looking for something around 0.12% or so on core, and instead got 0.16%. To be sure, this is another report that shows no sign of primary deflation, but still it amazes me that inflation breakevens can have such a significant reaction to what was actually just a mild surprise. That reaction tells you how pervasive the “deflation meme” has become – the notion that the economies of the world are headed towards a deflationary debt spiral. I am not saying that cannot happen, but I am saying that it will not happen unless somehow the central banks of the world decide to stop flushing money into the system. And honestly, I see no sign whatsoever that that is about to happen.
As I wrote last week, it should be no surprise that this is a dovish Fed that will perpetually look for reasons to not tighten, and will do so only when the market demands it. My guess is that will happen once inflation, breakevens, and rates rise, and stocks fall. And this doesn’t look imminent.
Outside of housing, core inflation still looks soft. But housing inflation is accelerating further, as has been our core view for some time. The chart below (data source: Bloomberg) shows the y/y change in primary rents is at 3.54%. The median in primary rents for the period for 1995-2008 (the 13 years leading up to the crisis) was 3.20%. And during that time, core inflation ex-housing was 1.72% (median).
Like most data, you can use this to argue two diametrically-opposed positions. You might argue that the Fed’s loose money policy has helped re-kindle a bubble in housing, as inflation in rents of 3.54% with other core prices rising at 0.78% suggests that housing is in a world of its own. Therefore, the Fed ought to be removing stimulus, and tightening policy, to address the bubble in housing (and the one in equities) and to keep that bubble from bleeding into other markets and pushing general prices higher. But the flip side of the argument is that core inflation outside of housing is only 0.78%, so therefore if the FOMC starts removing liquidity then we may have primary deflation, ex housing. Accordingly, damn the torpedoes and full steam ahead on easing.
The data itself can be used right now to make either argument. Which one do you think the Fed will make?
Follow-up question: given that the Fed has historically one of the worst forecasting records imaginable, which argument do you think is actually closer to correct?
I wonder how many times the Fed needs to be more dovish than expected before investors realize that this is a dovish Fed?
It may indeed be the most dovish Fed ever, judging from Dr. Yellen’s prior statements and history. And yet, investors seemed to have convinced themselves that with core inflation measured in the Fed’s preferred way far below its target (to be sure, it’s not the right way to measure it, but they’re not looking for excuses to hike), with structural unemployment still high (see chart of “Not in Labor Force, Want a Job Now,” source Bloomberg, below), with other central banks aggressively easing so that our dollar is aggressively strengthening, and with recent economic indicators surprising on the low side at the most-rapid pace since 2011, the Fed was going to put itself on a track to start hiking rates by early summer.
In the event, the Fed told us that they are no longer going to be automatically “patient” – which was the word that 90% of economists expected them to remove from the statement – but the Committee’s median projections for the year-end Fed funds rate dropped 50bps since the last meeting, to just above 0.5%.
Why won’t investors listen? It isn’t as if the last Fed Chairman was a renowned hawk. It’s been a generation since we had a real hawk in the Chairman’s seat. So I have no idea why it is a shock to people that the Fed acts dovishly, even as Chairman Yellen says the Fed will need to “monitor inflation developments carefully.”
If they were monitoring inflation developments carefully, they would know that median inflation is already at levels that represent achievement of the Fed’s target. If they were monitoring inflation developments carefully, then they would know that the dollar (which Yellen says will keep inflation lower for longer) has very little impact on domestic pricing, outside of goods that are largely produced overseas (apparel) or certain raw commodities (like energies).
Or, perhaps, just perhaps…they actually do know these things, but prefer to rely on obfuscation to keep rates as low as they can for as long as they can, until the market absolutely demands that they raise them. With market interest rates low, and the dollar strong, there is absolutely no market pressure for the FOMC to raise rates. Therefore, they will not.
At this writing, 10-year breakevens are +11bps on the day. Over the last week or two, after a mild bounce from the beaten-down lows, fast money had been leaning on breakevens again and pushing them inexorably lower. How do I know it was fast money? Because 10-year breakevens are up 11bps in a freaking hour, after a mild adjustment in the “dots.” That isn’t the sort of move that reflects long-term planning.
I continue to be flabbergasted at how the Fed maintains its credibility. We all know that the Fed has been considerably worse than the average economic forecaster over a long period of time. But it even seems to have trouble with current data. On the tape right now, the Chairman is saying that the “residual effects” of the financial crisis are restraining credit. Really? The chart below shows commercial bank credit. Does that look restrained to you? It is rising at better than an 8% pace y/y, the fastest level since May 2008. And it’s 10%-11% annualized on a q/q basis.
Sometimes I want to echo that commercial for Esurance. “That’s not how it works. That’s not how any of this works.”
When market rates go higher, and/or the dollar weakens because our domestic inflation starts being appreciably more than that of our trading partners, then the Fed will get serious about tightening. But it will have to be serious enough to handle the downward adjustment in securities prices that will happen when they begin to do so. I can’t foresee a time when that’s particularly likely. The Fed eschewed tightening over the last few years with an economy that had good momentum (see the first chart above). How likely is it that the Fed will get ambitious about hiking rates in the late stages of an expansion that is long in the tooth? With this Chairman? I wouldn’t hold your breath.
The defining characteristics of the markets these days seem to include:
- Central bank liquidity matters; central government mistakes do not.
- Central bank liquidity matters; economic growth numbers do not.
- Central bank liquidity matters; market illiquidity does not.
- Central bank liquidity matters; and so does the dollar (but that’s just a manifestation of the fact that central bank liquidity matters).
You may notice some commonality about the four defining characteristics as I have enumerated them above. I will add that this commonality – that seemingly only central bank liquidity operations matter these days – is also the reason that I haven’t been writing as much these last days, weeks, and months. As someone who has watched the Fed for a long time, I might have a decent guess as to when the Fed might change course…but probably no better than many other watchers. (Moreover, as I have said before, whether the Fed actually hikes rates or not probably doesn’t matter either as long as there is adequate liquidity, which is a question independent at the moment from rates. Refer again to the four characteristics.)
Let us take these one at a time.
Central bank mistakes don’t matter as much as the question of whether central banks are adding enough liquidity. Exhibit A is the fact that 10-year yields are negative in Switzerland, under 1% in France, Germany, Sweden, and the Netherlands, and under 1.60% in (get this) Italy, Spain, and Portugal. This is despite the fact that Greece is likely to leave the Euro either sooner or later, provoking existential questions about whether Italy, Spain, Portugal, and maybe France can also remain in the Eurozone. We can debate whether “likely to leave the Euro” means 20% chance or 80% chance, but if the chance is not negligible – and it certainly looks to be something more than negligible – then it is incredible that the Italian, Portuguese, and Spanish yields are all so low. Yes, it’s largely because of the ECB. Quod erat demonstrandum.
Economic growth numbers do not matter as much as central bank profligacy. The Citigroup Economic Surprise index for the US just fell below -50 for the first time since 2012 (see chart, source Bloomberg).
Now, weaker-than-expected data spelled bad news for stocks in 2008, 2010, and 2011, but not since then. I wonder why? Right: central bank liquidity trumps. Quod erat demonstrandum.
Recently, I have read a fair amount about increasingly-frequent bouts of illiquidity in various markets. The US TIPS market has comfortably more than a trillion dollars’ worth of outstanding issues, but has been whipsawed unmercifully over the last week and a half (after, it should be said, a hellacious rebound from the outrageous selloff in H2 of last year – see chart of 10-year breakevens, source Bloomberg). But that market is not alone by any stretch of the imagination. Energy markets, individual stock names and the stock market generally, and the list goes on.
It isn’t that there has been dramatic volatility – volatility happens. It’s that the effective bid/offer spreads have been widening and the amount of securities that can be moved on the bid and offer has been declining (to say it another way, the real market for size has been widening, or the cost of liquidity has been rising). This in itself is not surprising: some pundits, myself included, predicted five years ago that instituting the Volcker Rule, and other elements of Dodd-Frank that tended to decrease the risk budgets of market liquidity-makers, would diminish market liquidity. (See here, here, and here for some examples of my own statements on the matter). But the other prediction, that markets would fall as a result of the diminished market liquidity – less-liquid stocks for example routinely trade at lower P/E ratios all else being equal – has proven incorrect. Why? I would suggest the central bank’s provision of extraordinary monetary liquidity has helped keep markets elevated despite thinning liquidity. Quod erat demonstrandum.
So what is there to write about? Well, I could talk about the dollar, which at +25% from last June is starting to be in the realm of interesting. But this too is just another manifestation of central bank shenanigans – specifically, the notion that every central bank is being easier than our Federal Reserve. So it comes back to the same thing.
So all roads lead to the question of central bank liquidity provision. This primal single-note drum-beat is, if nothing else, exquisitely boring. But boring isn’t as annoying as the fact that it’s also wrong. The Fed isn’t being any more hawkish this year than it was last year. The growth in the money supply – which is the only metric of significance in the WYSIWYG world of monetary policy – is pretty much at the same level it has been for three years: about 6.0%-6.5% growth year/year (see chart, source Enduring Investments). That’s also exactly where UK M2 growth has been. Japanese money growth, while a lot healthier at 3.5% than it was at 2%, is still not doing anything dramatic despite all of the talk of BOJ money printing (color me surprised, by the way).
About the only interesting move in money growth has been in the EZ, which is where observers have been the most skeptical. One year ago, M2 growth in the Eurozone was 2.5%; as of January 2015, it was 5.6%.
The weakness in the Euro, in short, makes sense. The supply of Euros is increasing relative to the former growth trajectories, compared to USD, GBP, and JPY. Increase the relative supply; decrease the price. But the dollar’s strength against the rest of the world does not make so much sense. The supply of dollars is still rising at 6.5% per year, and moreover nothing that the Fed is proposing to do with rates is likely to affect the rate of increase in the supply of dollars.
At the end of the day, then, characteristic #4 I listed at the beginning of this article is wrong. It’s the perception of central bank liquidity, and not the liquidity itself, that matters to currencies. And that’s why I think the dollar’s run is going to come to an abrupt end, unless M2 growth inexplicably slows. How soon that run will end I have no idea, but it seems out of bounds to me. At least, if actual central bank liquidity is what matters…and for everything else in the securities markets, it seems to.