You know that monster threatening all we hold dear? We've decided not to worry about it.....

 

ref :- "U.S. Inflation Is Highest in 13 Years as Prices Surge 5%" , Wall Street Journal , Economy / U.S. Economy

All the financial media outlets have been spending a lot of time on the US inflation data released yesterday. We've chosen to reference the WSJ piece because it's a very comprehensive rundown on the numbers but frankly it's pretty hard to escape hard contemplation of the data wherever you look.

That's fair enough.... the subject is key as we know and the numbers were certainly eye-catching. Very briefly, US year-on-year consumer prices rose 5.0% in May (expected 4.7%)  -- that's the strongest reading since 2008 (as was China's CPI released earlier in the week, incidentally). Core CPI (excluding the volatile food and energy sectors) rose 3.8% (expected 3.4%), the most since 1992. One might have expected such a release to be the cue for further hand-wringing about looming runaway inflation unaddressed by current Fed policy. That would surely be bad news for bond markets which hate inflation (fixed interest and all that), and also for growth stocks behind much of Wall St's rise which would be ill-served by the prospect of higher rates too.

Er.... in the event, not a bit of it. The US 10yr Treasury yield fell to 1.43% (as prices rose, of course) and is 12 basis points down on the week  --  It traded 1.75% just six weeks ago. Stocks made record highs yet again.

Now, we have to hold our hands up here and admit that we were surprised at quite how phlegmatically the markets took the data, so it would probably be useful to remind ourselves as well market newcomers just how dangerous it is to look at such headline numbers in isolation and out of context. Consider the bigger picture.....

Market positioning, for example.... At its most simple you can look at things this way : Bond yields may have risen about 1% from the absolute nadir of the pandemic but as we've seen recent action has been on the downside. From that you can infer that a fair bit of book-squaring has been going on. We've seen an exiting of the big reflation trades that have been so profitable over a period of time (and involve shorting treasuries by one method or other) . More recent entrants to that type of trade  --  and there'll be plenty of them  who've been reacting to a raft of bond market heavyweights ringing inflation alarm bells  --  have been staring at losses. They may have been hoping that if they got strong data yesterday (which indeed they did) it would pretty helpful for the profit/loss position on their trading books. As it turned out, the market failed to react in the desired manner and in fact went the other way after the release, which would have encouraged more to abandon the trade and buy back short positions (sending prices higher and yields lower).

So why did an inflation reading of fully 5% fail to spook the market? Firstly, and most obviously, if you compare almost any reading today (when the recovery is firmly underway) to year-ago levels (when the pandemic was at its worst and the economy was on its backside), it's axiomatic that data is going to be strong. Beyond that, look beyond the headline number at the elements that have contributed to such a figure. For example, the index for used cars and trucks rose 7.3% May, and that was responsible for fully one third of the headline rise  --  yes, used cars and trucks, for goodness sake! Of course, this particular oddity is a function of supply chain problems (semi-conductors) that have held back production of new vehicles but you could apply similar provisos to much of what contributed to the final number.... if you were of a mind to that is, and the market plainly was.

Don't be fooled into thinking for one minute that this sanguine reaction to yesterday's data in any way represents a longer-term and more widely-held confidence that the huge spectre of galloping inflation has somehow gone away. It was a particular reaction to particular set of circumstances at a particular point in time. The Fed and others will continue to maintain that such inflationary forces are "transitory", whilst gnarled old bond market sages will continue to urge the Fed to start tightening now. The older ones will remember just how difficult it is to rein back those forces once they get away from you, and the deep recessionary effect of the measures ultimately required to do so (see Paul Volcker, Chairman of the Fed 1979 -1987). The jury is still out, will be for some time and is currently evenly split.

We hear that the Fed at their next meeting will discuss when and under what circumstances they would begin to "taper"  --  to reduce the amount of yield-suppressing, QE bond purchases from the current $120bn per month. The very word "taper" of course brings back bad memories of the "Taper Tantrum" of 2013, when then Fed boss Ben Bernanke rather clumsily suggested that was the course the Fed was about to embark upon.

One would hope that with the benefit of witnessing the terrible market reaction to that event today's Fed will handle things rather better. Even so, it would be naive to think that there won't be at least some serious road bumps for markets in the future. But for now we'll stick with the present, and the lesson of looking beyond the headlines....