As the sun breaks, above the ground
An old man stands on the hill
As the ground warms, to the first rays of light
A birdsong shatters the hill
His eyes are ablaze
See the madman in his gaze
Fly on your way, like an eagle
Fly as high as the sun
On your way, like an eagle
Fly and touch the sun
- "Flight of Icarus" Smith, Dickenson (Iron Maiden), 1983
Yikes!
The time was zero eight thirty on Wednesday morning. I could barely believe what my eyes saw. Nine point one percent.
There had been rumors that the headline print would hit the tap with a nine handle. Consensus had been for eight point eight percent. In fact, the entire range of professional opinion had only spanned from eight point five percent up to eight point eight, meaning quite simply that almost everyone had agreed on a number. Nobody high profile enough to be included in the consensus was higher.
So much for consensus. So much for "professional" opinion.
It was with unwelcome surprise that the Bureau of Labor Statistics posted headline inflation of 9.1% year over year, up from 8.6% in May and a new one month year-over-year high since November, 1981. That was the year of the mid-season baseball strike. That was also the month that I enlisted in the U.S. military for the first time. That was a very long time ago. The numbers are like a train wreck. Awful. Sickening. Yet, one can not look away.
Food inflation of 10.4%. Food at home, which is how normal folks try to save money, up 12.2%. Dairy... up 13.5%. Cereal... up 13.8%. Food away from home? Up "just" 7.7%. Not cheaper, but rising less quickly.
Energy inflation, better sit down... up 41.6%. Fuel oil, up 98.5%. Motor fuel, up 60.2%. Gasoline... up 59.9%. Piped gas... up 38.4%.
Ugly, yes... but look again at the categories selected. The horror show, while not confined to food and energy, is certainly centered on food and energy. Core July CPI printed at an above expectations 5.9%. Above expectations, but still lower for a third consecutive month. Rent, which is a big deal, is up 5.8% over the past 12 months. Terrible, but below core. New vehicles (+11.7%), used vehicles (+7.1), and transportation services (+8.8%) all forced the core print higher. Key core categories such as medical care services, medical care commodities, apparel, and all services unrelated to energy are rising at below-core levels.
What does this mean? We're digging into that. Stick around.
Pressure
I'm sure you'll have some cosmic rationale
But here you are in the ninth
Two men out and three men on
Nowhere to look but inside
Where we all respond to
Pressure
Pressure
Pressure
-- Billy Joel, 1983
Tension Builds
Suddenly, the Federal Reserve Bank is coming under increased pressure to once again, abandon already offered guidance on the trajectory of monetary policy while heading into a scheduled decision. Calls for a 100 basis point (1%) increase to be made to the target for the fed funds rate on July 27 stretch across that space in the universe where professional economics and financial markets interact, or should I say... clash.
The Fed has already communicated the intention to increase the fed funds rate by 50 to 75 basis points this month, as they had signaled 50 basis points going into the June 15 decision. The FOMC settled on a 75 basis point hike that day, and the heat is on once again this month as that headline CPI print scared the stuffing out of not just normal folk, but market-type folk as well.
In the wake of the BLS print, Atlanta Fed President Raphael Bostic, when asked specifically about a 100 basis point hike, said, "Everything is in play." Cleveland Fed President Loretta Mester, who does vote on policy this year, stated on Bloomberg TV, "We don't have to make that decision today." while also ruling out anything less than a 75 bps increase. Elsewhere, San Francisco Fed President Mary Daly told The New York Times that a full percentage point increase was within the range of possibilities.
Suddenly, my friends, the discussion around July 27 has rapidly evolved from 75 basis points as a ceiling for that rate hike into 75 basis points as a floor.
Argument
The Hawk:
The FOMC must be ever more aggressive in order to prevent expectations for elevated inflation from becoming entrenched.
Sarge:
The New York Fed's June Survey of Consumer Expectations show that respondents see inflation at 3.6% three years down the road, down from 3.9% in May. Respondents also see inflation at 2.8% five years down the road, down from 2.9%. One year out is a different story. Respondents see inflation at 6.8% in a year, up from 6.6%. The whole ball of wax, however, in my opinion, renders the argument that inflation expectations have become or are becoming un-anchored, invalid. It's just not there. Folks see inflation returning to something close to normal over a few years.
The Hawk:
The FOMC must be ever more aggressive in order to tighten monetary conditions, and choke off inflation here and now.
Sarge:
The above mentioned CPI release shows core inflation actually ebbing somewhat since March. Food and Energy, where the most painful inflation is, has been caused by warfare, plague, and scarcities scattered across the globe. Policy can not correct for imbalances caused through these means. Damaging demand where the demand/supply mechanism appears to be, if not healthy, at least healthier than elsewhere, will only deepen the current/coming recession to an unnecessary degree. I do not suggest dovish behavior, not in the least. Drain the balance sheet. Stay on course. Do not let lagging indicators for items that you know have already started to experience a correction in public price discovery force a panicked policy decision. Stay the course. Understood?
Furthermore, we turn to Wednesday's release of the Fed's Beige Book...
On The Economy:
"Several districts reported growing signs of a slowdown in demand, and contacts in five districts noted concerns over an increased risk of recession. Most districts reported that consumer spending moderated as higher food and gas prices diminished households' discretionary income."
On Labor Markets:
"Nearly all districts noted modest improvements in labor availability amid weaker demand for workers, particularly among manufacturing and construction contacts."
On Inflation:
"Substantial price increases were reported across all districts, at all stages of consumption, though three quarters noted moderation in prices for construction inputs such as lumber and steel."
Further and Necessary Explanation
It has become quite obvious that over the past 30 days or so, monetary conditions have started to tighten naturally. The FOMC has had nothing to do with this. The FOMC increased the fed funds rate by 25 bps in March, 50 bps in May, and 75 bps in June, taking that overnight rate to where it is now 1.5% to 1.75%. There has not been enough time for these increases to work their way into the broader economy, outside of mortgage markets. The Fed's balance sheet has only now just started to contract. This newly visible tightening of monetary conditions is occurring naturally due to items such as rapidly declining real wages. Real average hourly wages are now -3.6% year over year, as real average weekly hours are now -4.4% y/y (Source: BLS).
Futures markets trading in Chicago are now pricing in an 85% probability for a 100 basis point hike on July 27 and an 81% probability for an additional 75 basis points on September 21. After that, an additional 50 basis points are priced in by year's end. That's a fed funds rate of 3.75% to 4% by the holidays. Forget your Santa Claus Rally this year. Forget Santa for the kids too.
What does accelerating the already hawkish policy do to an economy that is slowing naturally as monetary conditions tighten ahead of the impact of policy? This is not hard to figure out. The U.S. Treasury yield curve tells you all you need to know.
Forget the 2-Year/10-Year yield spread, which is currently running at -23 basis points. The U.S. 1-Year Note pays 3.18% this morning. The U.S. 30-Year Bond pays 3.13%. That's right, U.S. 1-Year paper is inverted versus U.S. 30-Year paper. Why would anyone invest for less reward over 30 years versus one year at a lower rate?
Yet, the U.S. 30-Year Bond auction of $19B worth of debt was excessively strong on Wednesday -- 73.2% of the issue was taken down by Indirect bidders, or foreign central banks. Why would they do that? One. Perceived nominal capital preservation. Two. The carry trade. They simply see the U.S. dollar continuing to strengthen versus their home or other currencies, and continuing to do so over the long haul.
This is with a 1.75% fed funds rate. Now, picture if you will, the fed funds rate approaching 4% by year's end (five months away!!), while global investors continue to push down on the long end of the curve. You could, if this plays out, see extremely short-term T-Bills invert versus the long bond.
Dear FOMC...
You have an option. Don't be bullied by politics, by academia, or by financial professionals. You can simply keep your cool, and let already implemented policy impact the monetary base as well as the real U.S. economy, while staying within already provided guidance. Economic contraction is probably already upon us. Do not accelerate, or deepen whatever period of economic darkness visits our sweet land.
As always, I am here to help, and willing to do so.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 235K, Last 235K.
08:30 - Continuing Claims (Weekly): Last 1.375M.
08:30 - PPI (Jun): Expecting 10.8% y/y, Last 10.5% y/y.
08:30 - Core PPI (Jun): Expecting 6.9% y/y, Last 6.8% y/y.
10:30 - Natural Gas Inventories (Weekly): Last +60B cf.
The Fed (All Times Eastern)
11:00 - Speaker: New York Fed Pres. John Williams.
Today's Earnings Highlights (Consensus EPS Expectations)
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