OK, folks, the time has come. On Monday, I pointed out the three key factors that could have a major impact on the markets this week. As of Wednesday evening, all three have come to pass.
On Tuesday, the May retail sales report was released along with the Producer Price Index data (PPI). And Wednesday brought us the much-anticipated June 2021 Fed meeting.
As I’ve been saying for months — literally — inflation is the hot-button issue, and these three factors give us a good indication of where we’re headed…
But before we get into what everyone’s favorite former private equity partner, Federal Reserve Chair Jerome Powell, said at the June 2021 Fed meeting about inflation and interest rates, we should talk about the first two items from Monday’s list…
Readers that follow what I have to say, both here and in Venture Society, know that I’m not a fan of the Consumer Price Index (CPI) as a gauge of inflation.
The Fed likes to use it as a reference point, but I don’t love that it’s a backward-looking metric. I don’t care about where we were — because we can’t trade what’s already happened!
I want to know where we’re going.
So I look at the PPI — a leading indicator of CPI — to help me out. It gives us a real-time look at what inflationary pressures in the near term look like…
To be blunt… It’s climbing like we’re inside a pressure cooker. As I said in Tuesday’s Venture Society piece.
“PPI came in hot across the board, with overall month-on-month increases clocking in at 0.8% vs. 0.5% expected, and year-on-year figures showing a 6.6% increase versus 6.2% expected.
This is consistent with similar figures (such as prices paid and received), and just goes to show us that given the capacity of the economy to absorb it, producers will simply pass on cost increases to the consumer.
There will come a point when consumers push back — high prices, after all, are the cure for high prices.
But that time is not now.
And my guess is that at the June 2021 Fed meeting, Powell will use his favorite word for this inflation: transitory.
But we’ll get to that, as we have to tackle retail sales first.
The expectation prior to retail sales data being released was a decline in autos and gasoline, with possible improvements in other areas.
What we got instead was “sales continued to decline… just at an increasing pace.”
On its face, not a great result. But one silver lining might be that falling retail sales leads to slowing inflation, right?
Well, not quite… Not yet, at least.
Source: Bloomberg, Census.gov, BEA, Hedgeye
As you can see, many goods did decline, but some did the opposite. Autos, furniture, appliances and building materials all started to decline…
But each of those exploded in 2020, so a decline is to be expected.
What went up? Food, health care, gas stations and clothing. Guess what those did in 2020?
If you thought they had a comparatively bad year, you’d be correct. So we’re actually just seeing demand normalize here.
And as we see a transition from durable goods to more consumer-driven goods, we also have to expect a rotation from goods into services.
So, no, I don’t see this as inflation slowing. It’s simply changing.
And in fact, that rotation to other parts of the economy could just be getting started…
To the surprise of exactly no one, Powell’s speech at the June 2021 Fed meeting was a giant nothingburger, and the Federal Funds rate was held steady at 0% to -0.25%.
But the questions did get interesting.
The second one in — from The Wall Street Journal’s Paul Kiernan — got straight to the point…
“The (FOMC) Committee’s median forecast for inflation seems to assume a pretty tame outlook for the rest of the year. As you know, the three-month annualized rate was, I think, 8.4% on the CPI. And I’m just wondering, sort of how much longer we can sustain those kinds of rates before you get nervous?”
In response, Powell deadpanned: “So, umm… Inflation has come in above expectations over the last few months.”
Gee, thanks, Captain Obvious.
He went on to explain away high inflation by invoking used car and lumber prices — both of which have of course exploded over the past year — pointing out that they would eventually come down.
Captain Obvious strikes again.
Of course they’ll come down. The question is what level will they come down to?
Lumber, for instance, has corrected 40% off of its highs — no doubt about it.
Unfortunately, it’s still more than four times as expensive as it was a year ago.
And, yes, used car prices have gone completely off the chain. But while this particular spike has been drastic, the truth is that used car prices have been inflating since Hurricane Harvey roiled Houston back in 2017.
So when these prices “correct,” are they going to head all the way back to 2017 levels, or are they going to stick at higher levels?
I’ll give you three guesses, and the first two don’t count.
And this is before factoring in the increase in the “shelter” component of CPI, which comprises over 40% of the entire equation.
I hate to break it to ol’ J-POW, but as rising rents and housing prices get pulled into the CPI calculation, that is going to more than offset any sort of correction in lumber or used cars.
And contrary to his total BS answer to Kiernan’s question, that 5%, 6%, 7%, 8% inflation (depending on how you want to calculate it) isn’t going back to 2% anytime soon.
While it’s true the Fed did raise its interest rate projection by a full point to 3.4%, that forecast implies that inflation will average 3.8% for the remainder of 2021.
Considering the last print came in at 5% — without factoring in steel prices, the infrastructure bill or the coming bump in shelter and import prices — the actual chances of that happening are pretty damn close to zero.
And interest rates — my third item to watch for the week — did exactly what they’re supposed to do.
They spiked… As they should.
Because it doesn’t matter if J-POW admits that inflation isn’t exactly “transitory” after all…
At the end of the day, the market always tells us everything we need to know.
And today, the market is telling us that inflation is way stickier than what the Fed is saying.
All the best,
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