Fed policy at a critical time; A political misstep probably causes problems


Despite the CPI rising to a 39-year high, as reported on Friday, the S&P 500 closed at a record high. At 6.8% Y / Y (+ 0.8% M / M), annual inflation increased at the fastest pace since 1982. Core inflation (excluding food and energy) increased more modestly ( + 4.9% Y / Y) (+ 0.5% M / M). Still, the base Y / Y rate was the fastest since 1991. The financial media, of course, pointed out the most perverse aspects (all Y / Y data): Gasoline + 58% (most appealing to consumers Americans), Energy: + 33%, Used vehicles: + 31.4%, Food: + 6.1%.

Other aspects of inflation

The following aspects have not been discussed much in the media:

· Services inflation (the United States is mainly a service economy) + 3.4% Y / Y (+ 0.4% M / M). Although higher than desired, not that bad. The rise in prices is mainly due to the rise in the prices of consumer goods. The good news here is that officials at the Port of Long Beach have issued a statement saying they expect to make significant progress in reducing the port’s backlog over the next six months.

· Real average hourly earnings fell -0.4% in November and -1.9% year-on-year. Not a good sign for future consumption.

· Housing costs (both rent and imputed ‘owners rent equivalent’ (LRE) calculation) increased 3.8% year-on-year and will likely continue to rise over the next several months. But few remarks have been made on the record of multiple housing starts in recent months. Rents are likely to stabilize or even decline when they hit the market, possibly in the spring (a capitalist concept called “competition”).

· November’s CPI figure did not accelerate from October’s. This could be a sign that inflation has peaked. The following is an example of the fall from recent peaks in some important commodity prices:

It takes a few months for such trends to affect consumer prices, so in Q1 / 22 we should see a trend towards lower M / M inflation.

· In recent months, the University of Michigan Consumer Sentiment Survey has shown that consumers’ intentions to buy cars and homes are at their lowest in 50 years. Lo and behold, November auto sales were at an annual rate of 12.9 million units. 16-17 million is “normal”. This is the sixth drop in the past seven months and is -19% lower on an annual basis (yes, lower than November 2020, when the economy just started to unblock!).

· Redbook’s same-store sales comparison for major retailers was -5.6% M / M in November (could it be that everyone is buying online?). As we have noted in previous blogs, we believe the narrative of “shortages” has pushed retail sales forward and December’s retail sales will disappoint.

As noted above, on Friday December 10th, markets ignored the CPI report and moved higher, while bond yields edged down. Apparently, market professionals are seeing the trends described above.

Labor markets

On the sidelines, labor markets have also started to show signs of easing.

· In the most recent JOLTS (Survey of Job Openings and Workforce Rotation), job openings continued at record levels, but actual “hires” were down. (Part of the explanation here is the overall definition of an “opening” used in the investigation.)

· The financial media are in the news for the “record” level of initial jobless claims (CIs) we have had in two of the last three weekly CI reports (weeks of November 20 and December 4). As the table shows, it was 184,000 in the last week and 194,000 two weeks earlier. Unfortunately, these were seasonally adjusted figures (SA). The unadjusted numbers (NSA) tell a different story (see table and graph above), as they have increased in those two weeks (this has not been widely reported) and are still well above their “standard” before the pandemic.

You really have to wonder how a seasonal adjustment can reduce the unadjusted number by 34% (97K) in the case of December 4th.e data, and similar for that of November 20. In previous blogs, we have discussed the dangers of relying on SA data – suffice it to say here that the impacts of the pandemic are not seasonal.

Our observations regarding CI are corroborated by the huge jump (+ 398K or more than 25%) in Continuing Unemployment Claims (CC), (i.e. those who receive benefits for more than one week) for the week of November 27. from 1.561 million to 1.959 million. The Department of Labor (DOL) publishes a final reading for CCs, by state, with a lag of two weeks (the last is November 20) with an “advance” (estimated) reading with a lag of one week (27 November). The “norm” is for “advance” data to be lower than the “final” data from the previous week, as new claimants often have late payment claims. Thus, a large increase (25%) in “Advanced” data is significant and should be closely monitored. Due to the reporting process, when the data is finalized for the week of November 27 (to be reported Thursday, December 15), it is almost certain that it will be higher than the disproportionate number already in the “advance” estimate.

The huge jump in CCs described above gives us confidence that the weekly + 64K jump in NSA CIs shown in the table above (217K to 281K) is a much more accurate picture of the current job market than is the number SA 184K.

Money and the Fed’s upcoming deliberations

For fifty years, the markets have pretended not to pay attention to Milton Friedman’s observation that “inflation is always and everywhere a monetary phenomenon.” The table shows the growth of M2 (silver) over four rolling 13-week intervals. The attached table is also informative. Based on historical observations that it takes around nine months for monetary policy to have an impact on the economy, the right side of the chart shows the recent close relationship between M2 growth (with a lag of nine months) and CPI. Given the rapid deceleration of M2 since September (see table and graph with a 9-month lag), if the relationship continues to hold, CPI growth will slow down in the future.

The next Fed meeting is scheduled for Tuesday / Wednesday (December 13-14). They are at a critical juncture, and a political misstep could have major financial impacts.

Recently, Fed Chairman Powell has “pivoted” again, taking a more “hawkish” stance on inflation. Perhaps this was due to relentless pressure from financial markets, or perhaps for political reasons (to let the public know that the Fed will “fight” inflation). The data we have provided in this blog leads us to believe that neither the economy nor the labor markets are as strong as the “accounts” in the financial media would have us believe.

Financial markets are reacting to changes in Fed policy. So, if the “inflationary” rhetoric causes the Fed to tighten, there will likely be significant reactions in the equity and fixed income markets (on the dollar’s value against other currencies as well). In the current context, the reaction could be amplified as record amounts of leverage underpin all asset classes. An unwinding of this leverage will amplify market movements.

Here is the danger: If the economy turns out to be weaker than expected (disappointing retail sales in December, weaker labor market, falling demand for large items), a premature Fed tightening would be a major political misstep and could plunge the economy. economy in recession.

Market risks

Today, the stock and real estate markets are on edge:

  • The P / E ratio of the S&P 500 is more than 5 points above its long-term average.
  • The Shiller CAPE Ratio (Cyclically Adjusted PE Ratio) is three standard deviations above its mean; it was only higher in the era of the dot.com bubble.
  • Residential real estate – it takes eight years of average income today to buy a single-family home; the historical average is 5.5 years.
  • Commercial real estate – the capitalization rates are so low that there is no compensation for the risk in this market.

A Fed policy error could have significant financial implications.

(Joshua Barone contributed to this blog.)


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