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Two Seemingly Opposite Ends Of The Inflation Debate Come Together

It’s worth taking a look at a couple of extremes, and the putting each into wider context of inflation/deflation. As you no doubt surmise, only one is receiving much mainstream attention. The other continues to be overshadowed by…anything else. To…

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This article was originally published by Alhambra Investment Market Research

It’s worth taking a look at a couple of extremes, and the putting each into wider context of inflation/deflation. As you no doubt surmise, only one is receiving much mainstream attention. The other continues to be overshadowed by…anything else.

To begin with, the US Bureau of Labor Statistics reported today that US import prices were up on annual basis for the first time in some time. Rising in January 2021 by 0.9% year-over-year, this was actually the fastest increase in almost three and a half years; another one of these “highest in years” comparisons.

Not only that, just looking at the index especially clear acceleration the past two months (December and January), it does seem to be indicative of all that price overheating everyone’s been talking about.

Given enough time, has Jay’s flood finally started to come in? After all, import prices are linked to the dollar’s exchange value and global conditions, therefore if the long-predicted dollar crash is showing up it’s going to be costing Americans even more destructive inflation pain.



Hardly alone, appearing to corroborate the overheating alarm the BLS reported earlier in the week that producer prices have accelerated, too, also during these past few months. Like import prices, the PPI is up on annual basis and at the quickest pace in 26 months.

Here comes the seventies!



However, being higher than at any time during 2019-20 isn’t quite the comparison it’s made out to be. In fact, while produce and import prices are rebounding with commodity prices, in particular, that supply squeeze hasn’t really had all that much impact beyond turning several years of minuses into small pluses.

Yes, small.

Context matters:



And if this is the start of something big in the inflationary direction, why hasn’t it been so much bigger?

The reason in all likelihood is over at the opposing side where things continue to be actually huge. Inflation is talked about like it’s some massive monster already rearing its ugly head, while deflationary forces continue be, in reality as opposed to conjecture, truly mind boggling.

The labor market is still imperiled; the Department of Labor reported today on yet another rise in weekly jobless claims filings. Revising the tally from two weeks ago substantially higher, last week’s total beat it anyway at truly monstrous 863,000. As a reminder, there had never been a single week so much as 700,000 before last year.

As of the latest data, this makes 48 straight weeks at substantially greater than all prior record levels.




More concerning still is the trajectory; going back to the first week in November, jobless claims have been trending upward again now stretching into a third month. Not only is it consistent with the decline in payrolls over the prior two (the same December and January as producer and import prices accelerating), it’s perfectly consistent with a labor market which has stopped improving at a level of dysfunction and contraction commensurate with nothing else since the Great Depression.

Why does the first week in November sound so familiar? That had been the Presidential and Congressional elections, followed the next week by vaccines. Both of those were supposedly hugely positive and staunchly reflationary (if not full-blown inflationary, if commentary surrounding short-run PPI and import prices is to be believed).




But to those paying attention in a money, collateral, repo sense, early November instead comes back for vastly different reasons, as right when T-bill rates began moving noticeably lower. Not early January when bill supply became more of an issue, that’s when the move accelerated, but right at that same time as jobless claims and therefore the perceived underlying economy and monetary risks as I described them here.

Combined, import like producer prices together with jobless claims (and payroll data) both suggest those prices must be rebounding on supply squeeze factors alone, thus leaving overheated only the inflation talk that in the economy continues to be superseded by deflationary pressures that aren’t actually getting any better.

Uncle Sam may have been able to buy a few months of retail sales, but Treasury still can’t lead a jobs recovery – just as its bills price. And that’s really all that matters, or has mattered for the last thirteen years (see: PPI, Import Prices during that entire period).

Economics

The dot plot thickens

All eyes on FOMC meeting FOMC day finally arrives with markets already being buffeted by a variety of inputs. Although I expect the FOMC to not give too…

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All eyes on FOMC meeting

FOMC day finally arrives with markets already being buffeted by a variety of inputs. Although I expect the FOMC to not give too much away on the tapering front, the best we can expect I believe is a signal that they will make a firm decision on whether to start at the November meeting, we could in for a surprise on the latest dot plot. The dot plot, which charts FOMC members’ timelines for rate hikes or cuts could see more members moving hiking expectations into 2022. We may not get a taper tantrum lite from tapering comments, but we could from a more hawkish dot plot. I’ve long given up hope that US bond yields will react materially, but we could see a further extension to the US dollar rally and equities and commodities probably won’t have a good day at the office.

It is a busy day for central banks anyway with the Bank of Japan announcing its latest policy decision this morning. Like Indonesia yesterday, I expect no change from the BOJ, with a new prime minister to be chosen next week and an election to hold in the next couple of months. They may downgrade growth expectations and hint that more stimulus is ready should the economy slow, which should be supportive of Japan equities. Paraguay sneaked in a 0.50% rate hike this morning Asia time, and Brazil this evening, after the FOMC looks set to hike rates by another 1.0%. With Russia also on a hiking path, parts of the EM world could become attractive carry propositions if Mr Powell keeps the dovish hat firmly on. Turkey should be hiking, but that is a quick path to unemployment if you are the central bank governor.

Mainland China returns to work today although Hong Kong markets are on holiday in a game of tag. China has left its one and five-year Loan Prime Rates unchanged at 3.85% and 4.65% respectively as expected. Another RRR cut, probably early in Q4, is my favoured easing path for the PBOC. With one eye on the Evergrande saga, which has captured the world’s attention, the PBOC has injected a chunky liquidity injection today of CNY 120 billion via the 7 and 14-day repos. Whether that is enough to soothe frayed nerves in China remains to be seen.

What has soothed nerves is Reuters reporting that Evergrande’s Hengda Real Estate unit will make coupon payments on onshore bonds that was due tomorrow. That saw an immediate jump in the risk-correlated Australian and New Zealand dollars, and some buying coming into early Asian equity markets. However, the Evergrande story will keep on giving with the Financial Times reporting yesterday that Evergrande issued wealth management products sold to Chinese retail investors were used to plug financial holes in various subsidiaries. Concerns also swirl around its stake in a regional Chinese bank and whether it has been borrowing from itself effectively. The coupon payment story is likely only a temporary reprieve with no signals from the Chinese government over what steps, if any, it will take to assist an orderly wind down or restructuring.

US markets are contending with their own challenges in addition to the FOMC. The House of Representatives passed a vote to extend the US debt ceiling until after next year’s mid-term elections and will vote on a full bill today. It will likely be dead on arrival in the US Senate though, with Mitch McConnell as much as saying so, forcing the process into reconciliation to pass. The tiresome gamesmanship over the debt ceiling from both sides should be another reason for the Fed to stay on the cautious side of things this evening.

Natural gas prices continue to make headlines with European gas prices having climbed by over 400%. Most of the noise is around the 10-20% of gas that producers keep for the spot market and here it seems Asia is winning the bidding war. Gazprom is reluctant to increase export volumes to Europe above contracted amounts, meaning no spot gas. Bemusingly, signals from Russia suggest that a quick approval and certification of the new NordStream2 pipeline could result in an immediate increase. All Europe and Asia, to a lesser extent, can do, is hope for a mild winter at this stage. Europe is paying the price for its naivety in tying energy security to Russia in the hope that it would be a reliable partner. That’s like me turning structurally bullish on cryptocurrencies and starting to call them an investable versus tradeable asset class.

For today, Evergrande has knocked the FOMC meeting into second place in the attention of Asian investors. I expect regional markets to be buffeted by headlines emerging from that situation and the price action after the coupon payment news suggests dip buyers hungrily await in everything if even tenuous positive news arrives.

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Economics

When Will “Transitory Inflation” Overstay Its Welcome?

There has been much talk of "transitory inflation", but the evidence is starting to suggest the term may overstay its welcome.

The Fed chose the word…

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There has been much talk of “transitory inflation”, but the evidence is starting to suggest the term may overstay its welcome.

The Fed chose the word “transitory” to describe this instance of rising prices because of its imprecision. Transitory can denote hours, months, or decades. Using transitory versus a specific period provides the Fed freedom to be wrong but be grammatically correct.

While the Fed uses ambiguous words, Mr. Market may have more defined expectations. If investors grow impatient with the Fed’s transitory, bond markets may react. In such a case, how will the Fed respond to “enduring” or “lasting” inflation coupled with higher yields? If they are already tapering, will such conditions push them to speed up their pace?

Conversely, recent data shows inflation may be stabilizing. Maybe the Fed is correct, and inflation rates will normalize in the coming months. If so, will they hold off on tapering or reduce the rate of tapering?

In July, we wrote Just How Transitory is Inflation?  The article is a deep dive analysis of CPI. At the time, we sought a better understanding of what was causing inflation to rise. With two more months of inflationary data, an update is essential.  

Understanding inflation beyond the headlines helps us answer the all-important question: Just how transitory is transitory? From there, we can begin to assess potential Fed and market reactions.

Headline CPI Summary

In the latest CPI report, covering August, the monthly CPI figure rose by 0.3% or 3.6% annualized. The year-over-year rate is +5.30%. In comparison, June’s monthly CPI rose by 0.90% or nearly 11% annualized. Despite the big difference in monthly rates, June’s year-over-year change of +5.40% is only 0.10% higher than August.

As shown, the monthly CPI and core (excluding food and energy) are turning lower. While not as pronounced, the annual data is following suit. Two months does not make a trend, but it appears to be fulfilling the transitory definition. Core CPI, at +0.10% last month, is 0.10% below the average for 2017-2019. Headline CPI is only 0.10% above the average.

The headline data is supportive of the transitory narrative; however, it does not tell the whole story.

The Breadth of CPI

Digging deeper into CPI and looking beyond the headline averages may not support the word transitory. The graph below shows the CPI Index based on the median price of the goods and services in the index. Unlike the headline CPI Index, median CPI is still rising and at the highest level since 2008.

The distribution graph below compares June to August regarding how the prices of all the underlying goods and services within CPI are changing on an annual basis. We separate the data into 2% price buckets.

The blue (August) and orange (June) bars comparing the two months may look somewhat similar, but there are differences worth discussing.

In June, 75% of the CPI components were rising at a rate slower than the 5.4% inflation rate. In August, 71% were rising at a slower rate than the 5.3% rate of inflation.

The number of goods whose prices rose between 2% and 10% increased from 66 to 77. The number of goods whose prices rose by 2% or less fell from 72 to 55. While subtle in the graph, the number of goods shifting to the right (more inflation) is noteworthy.

52 of the goods and services have price declines from June to August. Six were unchanged, and 95 had price increases. Again, more goods are rising in price than falling.

The breadth of the market is not supportive of the transitory theme. A wide swath of prices are broadly rising, albeit not at an alarming pace.

Outliers

In the original article, four goods had year-over-year price changes of greater than 20%, as shown below.

  • Used Cars 45.2%
  • Gasoline 45.1%
  • Fuel Oil 44.5%
  • Other Motor Fuels 32.1%

In the August report, six goods had greater than 20% increases. The four goods from June maintain annual 20% rates of inflation. Added to the list are propane and utility services.

The inflationary outliers continue to be energy and auto-based. Both are rising in large part due to the reopening of the economy and supply disruptions. We expect both will moderate in the coming months. As this occurs, they will put less upward pressure on the CPI Index.

Employee and school cafeteria food prices are down well below 20%. Over time these should moderate as schools and offices come online. Such will result in inflationary pressures.   

Big Contributors

In June, 92% of CPI was due to the price changes of the ten largest index weightings, as shown below. Those ten goods played slightly less of a role in August, contributing 82% to the change in the index. Below is a comparison of the same ten contributors for June versus August.

The prices of Used Cars and Transportations rose at a lesser rate than June, but every other category was little changed.

In the original article, we warn Shelter prices are the most considerable risk to more inflation. Driving our concern is Shelter’s 30%+ contribution to CPI and rapidly rising home and rent prices.  As we show above, higher home and rental prices are barely making their way into CPI.  

What gives?

In our article BLS’ Housing Inflation Measure is Hypothetical Bull****, we stated: It appears impossible to calculate the BLS version of OER or rent.”

We remain concerned that a double-digit increase in rent and home prices (OER) will push Shelter prices higher in the months ahead. However, history proves reality, and the BLS Shelter measure has a near-zero correlation.

Flexible Prices

As we wrote in June, CPI tends to be heavily correlated with goods and services that have flexible prices. These are goods like gasoline, whose prices tend to fluctuate both up and down. The Atlanta Fed publishes data on flexible and sticky prices, as shown below.

The graph shows sharp increases in both flexible and sticky-price goods are leveling off over the last two months. Given the Atlanta Fed measure of flexible prices has a 96% correlation with CPI, we are hopeful the upsurge is halting.

Expectations

The graph below shows a glaring divergence between Wall Street inflation expectations and those of Mom and Pop. Five and ten-year market-implied inflation expectations have been stable since January. All the while, the University of Michigan survey of consumers sees steadily rising inflation expectations.

While Wall Street buys into the transitory theme, consumers are not. This divergence matters as personal consumption drives about two-thirds of economic activity.

The New York Fed, via their latest Consumer Expectations Survey, highlights why confidence is weak. Per their survey, expected inflation is now over 5% and rising. At the same time, expected wage growth is 2.5% and stable/falling. As a result, consumers expect to lose 2.64% (red line) in purchasing power over the next year. Would you be confident taking a 2.64% pay cut?  

Summary

We are witnessing unprecedented pressures on the supply and demand side of pricing equations. Forecasting, with such uncertainty, is challenging. As such, we maintain a humble approach to inflation forecasting.

The latest round of data provides some evidence inflationary pressures are abating. However, the breadth of the data tells us there are still many goods and services still rising in price. This difference may help explain why consumer inflation expectations are higher than the market’s and confidence is falling.

Just How Transitory is Transitory? We suspect the market will have its answer in the next few months. Prolonged rising or high inflation beyond December will likely get many to question if inflation is truly transitory. Until then, pay attention to headline inflation, the breadth of the data, and especially any effects from rising Shelter prices on CPI.

The post When Will “Transitory Inflation” Overstay Its Welcome? appeared first on RIA.

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Economics

PVC Prices Hit Record High As Homebuilding Costs Soar

PVC Prices Hit Record High As Homebuilding Costs Soar

The cost of a key building material used in everything from vinyl siding to gutters…

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PVC Prices Hit Record High As Homebuilding Costs Soar

The cost of a key building material used in everything from vinyl siding to gutters to windows and doors to flooring to plumbing jumped to a fresh record high.  

U.S. Gulf Coast export PVC spot prices printed $1,900 per metric ton for the week ending Sept. 10, up more than 30% since June. 

According to Bloomberg, the latest jump in prices is due to Hurrican Ida disrupting 60% of the U.S.' polyvinyl chloride production. The hurricane delivered a devastating blow to petrochemical factories on the Gulf Coast as buyers go elsewhere for plastics. 

"We're now hearing some buyers there are looking to Asia for supply at the moment," Jeremy Pafford, head of North America's Independent Commodity Intelligence Services. "Expectations are that the tight supply situation will continue for several weeks."

Homebuilders and homeowners cannot catch a break when it comes to the cost of materials. Earlier this year, lumber jumped to new heights on supply chain woes but has since plunged, though it remained more than double the prices from COVID lows. 

D.R. Horton, the largest homebuilder in the US, warned Monday that "significant disruptions in the supply chain ... along with tightness in the labor market" will dent the full-year sales forecast. The update comes as similar warnings from homebuilder PulteGroup earlier this month warned that "shortages for a variety of building products, combined with increased production volumes across the homebuilding industry, are directly impacting our ability to get homes closed to our level of quality over the remainder of 2021."

"Runaway construction cost growth, such as ongoing elevated prices for oriented strand board that has skyrocketed by nearly 500% since January 2020, continues to put upward pressure on home prices," said NAHB Chairman Chuck Fowke. 

"Policymakers must address supply chain bottlenecks for building materials that are raising costs and harming housing affordability," Fowke added.

There could be more rallies ahead for PVC prices as there is no clear timeline on when petrochemical factories in Louisiana will come back online. One thing is sure: the cost of manufacturing PVC has risen due to soaring natural gas prices. 

As for now, the cost of building a home continues to rise, and it appears that inflation is becoming more persistent, discrediting the Federal Reserve's "transitory" narrative.  

Tyler Durden Wed, 09/22/2021 - 05:45
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