There was supposedly no market reaction on Tuesday to the rather unsettling data released for U.S. June consumer level inflation. Until there was.
Markets took the numbers in stride upon release. It wasn't until yields started moving at around 13:00 ET, triggered by a weaker-than-hoped-for auction of $24 billion in 30-Year Treasury bonds, that equities showed weakness alongside the deeper end of the yield curve.
The auction I speak of saw indirect bidders (foreign accounts) take home $14.6 billion, or 61.1% of the issuance. Not the end of the world, but well below the 64% above-average total awarded to such accounts for this series back in June. Direct bidders also showed less appetite at just under $4 billion, or 16.6%, sticking primary dealers with a $5.3 billion (22.3%) door prize. In all, bid to cover amounted less than 2.2 times (lowest since February), as the high yield awarded landed at an even 2% despite the fact that the "when issued" had traded at a yield of 1.976% going into the event.
One must ask why? Why were fewer accounts willing, at a lower price than expected, to pay a lower price for the right to hold U.S. sovereign debt for 30 years? Then again, if one thinks rationally, why is there any demand at all for paper yielding 2% over 30 years, when headline inflation runs at 5.4%, core inflation at 4.5%? That might be the more pertinent question. Capital preservation with some nominal return?
Understand that if year-over-year inflation moves from 2.6% to 4.2% to 5.0% to 5.4%, and the U.S. 10-Year note over that same time frame pays 1.75%, then 1.60%, then 1.25% and now 1.40%-ish, then already negative real rates are indeed more deeply negative than they have been.
It turns out that Wednesday and Thursday will prove to be perfect timing to put Fed Chair Jerome Powell on the national stage, and hear his opinions, or his representation of his team's opinions on the state of inflation. Readers will need to be cognizant that June 2020 was the first month where the lockdown-induced contraction in consumer prices reversed higher after three straight negative months, simply meaning that the "base effect" that had bloated inflationary pressure across the U.S. should have, in a logical world, started to abate with this read-out. It is clear that most professional economists had built their expectations for June with this in mind.
Unfortunately, at a time where a deep understanding of economic theory crossed against economic projections and then checked by economic reality, with serious back and forth required between questioners and the nation's head central banker, the best we have to offer is those serving on the House Financial Services Committee one day and the Senate Banking Committee the next. This almost ensures that serious questions will go unasked, while scoring superfluous political points or making sharp, but hollow soundbites will be prioritized. As mentioned, this is unfortunate.
It is likely, in my opinion, that Powell will stick to the Fed narrative that (while the inflation we have seen might be a bit more aggressive than expected and may be stickier than hoped for) this inflation remains "transitory" in nature. To perhaps surprise the reader, and stun the shopper, I still think that narrative has merit as well. You see, I did the family grocery shopping on Tuesday after work. I expected the damage to be worse than it was. Indeed, food at home ran 0.8% higher for the month, below the headline and core month-over-month pace. The story, though seemingly broad, is still centered around used vehicles, which is a simple product of supply chain constriction slowing semiconductor shipments that crimp the availability of new vehicles.
Used Cars & Trucks printed up 10.5% month over month for June, after printing +7.3% for May, and +10% even for April. The category now shows a 45.2% year-over-year increase. Excluding this one category, the month-over-month growth in consumer pricing moves from 0.9% to 0.5% at the headline and from 0.9% to 0.4% at the core. That would also place results right around professional consensus. Simply put, if you are not in the market for a vehicle right now, inflation is right where the pros thought it would be. You think used car prices level off after the chip producers catch up, also easing new car prices? Hmm. So do I.
Let's go one step further. Energy prices are up 24.5% annually, and remain well above trend month over month. Do you think with OPEC + in disagreement, there will be more or less crude oil pulled out of the ground? How about U.S. production with WTI Crude trading at $75 a barrel? The moves have been small, but it has now been 10 weeks since the last reduction in active U.S. oil rigs in operation. Last Friday, this number crossed at 378. In late April? 342. Now, do you really see gasoline, fuel oil and utility gas prices continuing on as they have? I do not. Downward pressure on fuel prices could also ease consumer prices for transportation services. (another hotspot).
The Fed does not necessarily need to act just yet, outside of what I have already prescribed, which is not just the reduction of, but immediate halt to the purchase of $40 billion worth of mortgage-backed securities per month. This is not a change for me, I have been calling for this for most of 2021. That one act alone would ease consumer costs for shelter, and permit household formation to grow across younger demographics that have seen the natural pace of their personal development impeded by this most unnecessary support for a market that hasn't needed any support whatsoever at any point this year.
Those who will in a blanket way say the Fed needs to raise rates in order to arrest inflation must understand that to simply increase short-term rate targets without ensuring that longer-term rates have the freedom to move in lock-step would almost certainly also arrest the pace of economic growth as yield spreads contract.
The Fed's dual mandate requires the central bank to work toward price stability and maximum sustainable employment. Under Jerome Powell, after the initial mistakes made in 2018 and up into pandemic response, the Fed has been outstanding. They now stand at the precipice of potential error once again, and that error just might be taking action (beyond MBS markets) prior to knowing just how aggressive our legislators will be, or can be on the fiscal side.
Perhaps it is Powell who should be asking the questions this afternoon. Then again, in that case, who would even venture a bet that those questioned would even be read up on the material sufficiently enough to answer.
On That Note
The U.S. Treasury Department reported a budget shortfall of $174 billion for June, which believe it or not, was much better than expected. The nonpartisan Congressional Budget Office now projects a $3 trillion budget deficit for fiscal 2021 without further spending. Wonder what the odds of that are? The all-time record negative balance for one year is $3.13 trillion, set last year.
Forget the Biden administration's aggressive goals for increased deficit spending, or the on-again, off-again bipartisan negotiations for a much smaller infrastructure-based deal that leaves out most of the spending on social programs. Treasury Secretary Janet Yellen says that her department will end July with a cash balance of $450 billion (was $718 billion last week).
If Congress does not act to increase or further suspend the debt ceiling (currently a rough $22 trillion), Treasury will be left unable to pay its bills or make regular payments such as those required by the Social Security Administration or Defense, which means that there will likely be action taken. Still, be alert that this is out there, and if Congress somehow fumbles, which they are most certainly capable of, there are only poor outcomes.
1) Just as I publicly considered Lockheed Martin (LMT) , 864 unresolved software and hardware deficiencies of varying severity that could undercut the combat readiness of the F-35 fighter aircraft show up. The stock is moving toward support as the company had landed over $6 billion in new contracts this past June. This, however, is troubling. I am holding fire for now. $373 is a crucial spot.
2) Apple (AAPL) is partnering with Goldman Sachs (GS) to develop a new service allowing consumers to pay for Apple's consumer electronics goods in installments. This would not be related to the Apple Card (the existing credit card partnership between Apple and Goldman Sachs), but would encourage the use of Apple Pay. The program is reportedly (by Bloomberg News) referred to as "Apple Pay Later" internally,and comes just as news breaks that Apple has requested as many as 90 million next-generation iPhones from suppliers, above the norm of about 75 million. Apple is also expected to announce the new phones in September, one month earlier than usual. Trying to read the tea leaves... Apple expects to raise prices and sell a lot more new smartphones this holiday season than it has in recent years. This is positive for Apple, for Goldman Sachs, and for Taiwan Semiconductor (TSM) .
3) According to the American Psychology Association's annual stress survey, 42% of the U.S. population gained unwanted weight during the pandemic, averaging 29 pounds each. I do not find the 42% number surprising. I am stunned, however, by the 29 pounds. While there will be a valid attempt by many to lose weight or get back in shape as they are called back to the office, there will not be sufficient time. I expect to see an absolute burst in retailing across the apparel space that will culminate around the "Back to School" season. In addition, WW International (WW) , the old "Weight Watchers" has been drifting lower, even as membership increased 16% from one year to the next as of the end of the first quarter. Can't "wait" to see the second-quarter numbers. Get it? The shares closed at $32.67 on Tuesday, down 3.46% for the day, and well off of a $41.13 June high. Investors beware that an unfilled gap still exists between $26 and $28 from back in May.
Economics (All Times Eastern)
08:30 - PPI (June): Expecting 6.7% y/y, Last 6.6% y/y.
08:30 - Core PPI (June): Expecting 5.1% y/y, Last 4.8% y/y.
10:30 - Oil Inventories (Weekly): Last -6.866M.
10:30 - Gasoline Stocks (Weekly): Last -6.076M.
The Fed (All Times Eastern)
13:30 - Speaker: Minneapolis Fed Pres. Neel Kashkari.
12:00 - Speaker: Federal Reserve Chair Jerome Powell.
14:00 - Beige Book.