After the massive surge in spending and stimulus globally since COVID, central banks have justified their expansion by claiming that inflation would only be transitory. Low and behold as the months go by, the numbers get worse and worse, that even some of the more dovish members have succumbed to admitting that "inflation does look rather elevated".
To call it elevated is an understatement as U.S. consumer price data released yesterday saw prices soar 6.2% yoy in October, far higher than the 5.9% yoy expected. This was the highest point since June 1982! Core CPI surged 0.6% in October, boosting the core rate to 4.6% yoy from 4%, the highest since 1991! It was not only energy and food, but also pressure picked up from shelter inflation and some of the more transitory factors.
It confirmed that this inflation is alive and real and there is nothing transitory about it.
The million dollar, oops sorry, trillion dollar question now is, what will or can the Fed do about this? They will do what they always do, keep quiet, watch the screen, hoping and wishing that the numbers come back down to more "average" levels. They are stuck in a bit of a Catch-22 situation, where they cannot print anymore to boost the slowing GDP growth being witnessed, and if they raise rates to combat this inflation, they will kill the entire financial system as we know it. Their only choice is to let time pass and hope that prices come back down.
There is no doubt that core inflation is easily above their sustainable 2% target and what they should do is at least stop their ridiculous buying of Treasury assets of $105B per month altogether, forget raising rates which should have been done earlier this year as the market rejoiced and bounced. Now it is too late.
The market is so used to the constant addition of liquidity that like an opioid addict, it cannot survive without it. Every hiccup or bump on the road requires more and more of a feeding frenzy, to the point that $1 trillion seems meaningless as just a few more 0's to the ledger. One thing is clear, the Fed and other developed markets central banks are far from normalizing their balance sheet. Their solution was to inflate the debt away, which may sound good in essence given the inflation we are seeing. But if this consumer price inflation is not met with real wage inflation, then the average consumer will be left devastated as their real disposable income falls dramatically, and that could be the end game.
There is one outcome given the slowdown witnessed in China and the pullback in some key commodities like gas, oil, and other basic resources like iron ore and steel. We could start to see some reprieve in the higher than expected CPI numbers. But a small pullback will not be enough as the bond market is not convinced the Fed has it right. The belly of the curve is seeing some strange moves and the 5/30s and 10/30s is showing signs of inversion, suggesting that they are convinced that this is going to end up being a Fed policy error. The bond market is a hugely significant one, and any big moves or changes in themes can impact other asset classes very easily and cause deleveraging across the board.
It is also important to keep an eye on the dollar, even though it has been the most boring asset all year. It is starting to break above its key summer range above $94.5, but will it actually stay up? The Fed can keep saying whatever it wishes, but the bond and rates market may beg to differ.
Only time shall tell who will be proven right and who wrong. We can easily guess who the latter will be, and if so, they will just print their way out of it all again. Perhaps it's time to say goodbye to Fiat once and for all.
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