On Thursday, June 10, despite a headline CPI of 5.0% Y/Y, the highest reading since August 2008, the “Inflation Narrative” turned on a dime. How else can one explain the rapid 12 basis point (0.12 percentage point) decline in the 10-Year Treasury Note yield, over half of which occurred after the CPI data release?
“Inflation Jumps to a 13-Year High” screamed the headline on page A-1 of Friday’s (June 11) Wall Street Journal. As indicated above, the article noted that this was the highest reading since August 2008, and it provided a small chart showing Y/Y CPI changes back to the year 2000. We have duplicated part of that chart (see above), as we found it curious that no mention was made of the precipitous drop in inflation over the ensuing year. On the left-hand side of the chart you can see the 5.5% peak in July 2008. A year later, the CPI reading was -2.0%! We think something similar is possible in today’s economic environment.
Given that the 5.0% Y/Y CPI reading was higher than consensus (4.7%), why are longer term Treasury yields now falling.
Our position on inflation for many recent blogs has been its “transitory” nature. The Fed has maintained this view despite harsh criticism from major Wall Street financial firms. The fact is, all the Regional Federal Reserve Bank inflation models back this view. For instance, the Cleveland Fed’s weighted-median index showed up in May at 0.26% M/M, up ever so slightly from its 0.24% April reading.
Almost inexplicably, on Thursday (June 10) the Wall Street Inflation Narrative shifted such that the “transitory” idea was now viewed as, at least, “viable.” As of this writing, the new “transitory” narrative hasn’t been universally adopted, as it sometimes takes time for Street “buy-in,” but we predict that this new sentiment will become pervasive as the economy “normalizes” over the next couple of quarters.
The catalyst for the narrative shift was the recognition that the price changes in May’s CPI were heavily skewed to those sectors that were most heavily impacted by the pandemic (leisure/hospitality, travel…) and that the categories of prices that have historically been highly correlated with underlying inflation were much more subdued.
- Car Rental: 12.1% M/M May; 16.2% M/M April
- Airline fares: 7.0% M/M May; 10.2% M/M April
- Used Vehicles: 7.3% M/M May; 10.0% M/M April
Economist David Rosenberg blogged that the reopening sectors, representing 20% of the CPI weightings rose 2.5% M/M in May, while the other 80% of the CPI weightings rose 0.15%! Thus, the bulk of the price increases in May were confined to just a few (re-opening) sectors.
More Inflation Observations
The rising CPI did have an impact on “real” average weekly earnings. They declined -0.15% in May compounding the -0.10% fall in April. In late 2020, we saw a significant deceleration in GDP components from September through December as the impacts of the initial stimulus (free money) payments wore off. Similarly, we saw the first vestiges of this in April’s retail sales, as they fell slightly from March on a nominal basis. This looks to be the result of the initial fading of the impact of March’s stimulus checks. We expect that, without yet another round of free money, flat retail sales will be the pattern through year’s end. As a result, we see little upward pressure on interest rates. Our view is that Treasury rates will fall from here until the Fed begins to tighten policy. And, given the Fed’s new-found sensitivities surrounding social issues, we don’t expect that to occur until, at least, 2023.
Once again, Initial Unemployment Claims (ICs) fell in the week ended June 5, not a surprise in a re-opening economy. Remember, this is a proxy for new layoffs. The chart below shows IC levels for the last week of each month beginning with the pre-pandemic February 29, 2020 week. You can see that, at current rates of decline, “normalization,” i.e., a return to pre-pandemic levels, may actually occur in July or August!
But ICs are not what concern us. CCs (Continuing Unemployment Claims – those receiving unemployment checks for more than one week) are where we are troubled. Too many unemployed remain on the sidelines, apparently ignoring the pleadings (“the ubiquitous “Help Wanted” signs) of re-opened businesses.
The latest JOLTS (Job Openings and Labor Turnover Survey)(April) shows a record 9.3 million job openings, but with muted hiring data. Likely May will show yet another record reading with little job uptake. The Continuing Claims chart shows data beginning with the week of March 14, 2020 and plots the data from the last week of each month since. Note the very mild downslope on the chart in 2021, which coincides with both re-opening and the federal supplemental $300/week unemployment benefit. At the latest pace, it will take nine more months to reach the pre-pandemic level. Of course, we don’t think it will take that long as the federal supplemental payments, which we believe are the primary disincentive keeping the unemployed on the sidelines, expire between June 12 and September 6. The table shows, by date, the number of states that will eliminate the federal $300/week supplement and the percentage of the total unemployed in the state programs that those state groups represented on a week-by-week basis.
We postulate that as we approach the end of July, the percentage of total unemployed will be significantly lower in those 24 states and higher in the 26 states and three territories that have elected to continue the supplement. Stay tuned!
Despite heightened inflation data, we detect a sentiment shift in financial markets toward acceptance of the “transitory” inflation view. The Fed meets June 15-16, and we expect that the resulting minutes will show a discussion of “tapering” the $120 billion/month bond/mortgage purchase program. But we view it unlikely that the program will end soon. In addition, the new market acceptance of the “transitory” inflation view should take a lot of pressure off the Fed to move interest rates higher. Markets have already responded by moving intermediate and longer-term Treasury rates down. And, from the viewpoint of a couple of economists, since the economy isn’t “roaring,” why would the Fed step on the monetary brakes?
The bigger issue is the labor data which shows a recovering economy (layoffs falling), but one held back by poor fiscal policy. We think that the $300/week supplemental payments will have a negative long-term impact on the labor market, as, unable to find employees, recent business investment in automation and labor-saving practices has resulted in a decade high growth in productivity (>4% in Q1). Such ongoing investments will make re-achieving a 4% unemployment rate a much longer journey, another reason for the Fed to keep administered rates pegged to the floor. This only reinforces our belief that the Treasury yield curve will be lower at year’s end than it is today.
(Joshua Barone contributed to this blog.)Robert Barone
Robert Barone, Ph.D. is a Georgetown educated economist. He is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (NYSE Symbol: FFIU). Robert is also a financial advisor at Four Star Wealth Advisors. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, a Director and Chairman of the Federal Home Loan Bank of San Francisco, and. similarly, a Director and Chairman of the CSAA Insurance Company (the AAA brand). Robert currently is a Director of the AAA Auto Club of Northern California, Nevada, and Utah, and a Director of Allied Mineral Products (Columbus, OH), America’s leading refractory company.