Change the Narratives

While I was enjoying the Sun at Rhodos last week, I am really happy that I can write about actual market events again and am able to give you my thoughts about it. 

There are several things I want to talk about: Firstly, there was the September meeting of the Federal Open Market Commitee, where markets expected to get some guidance about the future path of monetary policy (Spoiler: They did not get much)

Secondly, there was a lot of talking about Evergrande. The Chinese property developer got into liquidity problems and as a result markets freaked out slightly at the beginning of the week. However, in retrospect it was only a brief downmove before everyone jumped on the bandwagon again and bought the dip. 

However, I would like to start with THE topic of 2021, a topic that nearly has been forgotten in previous decades. You already know it, it is Inflation. Last week we got US-inflation numbers for August and a big sight of relief from the Tranisitory camp. 

For the first time in months inflation came in below expectations and therefore some economists and analysts interpret these numbers as a sign of slowing inflation dynamics. 

Monthy inflation rate in August was 0.3 % (0.4 % expected), while core inflation was only slightly higher as compared to July (+0.1 %). Year-over-Year inflation came in in line (+5.3 %), ex-Food & Energy, YoY-inflation has been .2 percentage points below expectations, at 4 %.

As a result, monthly core inflation is back at levels we have seen before the crisis and it seems that people like David Rosenberg or Jeff Snider seem to be correct on their inflation forecast (that there is no inflation)

Year-over-Year inflation, however, does not look as good as monthly comparisons. Compared to last year, inflation was still way above the Fed's 2 % target, although one can observe a possible reversal in the trend.

If one digs deeper, you will find exactly what Deflationistas have pointed out for several months now to explain the recent spike in inflation. 

The biggest drivers of inflation in the last few months have been used-car prices and travel services. In August those two components of the CPI fell. What goes up, eventually goes down, something what is definitely true for US-CPI in August.

The Biden is already celebrating. From Reuters: The Biden administration on Tuesday welcomed data showing that consumer prices increased at their slowest pace in six months in August as evidence that inflation would be transitory, citing a drop in auto prices and a deceleration in food price increases.

Everything is fine again, right? Well, I am not so sure about that. Of course everyone could have known that inflation would decelerate at some point. Back in July I guessed that US-inflation may have peaked already.

Nevertheless the situation has changed since the Great Financial Crisis of 2008. 

There is a joke among economists that economists have been invented to make meteorologists look good.

Following chart shows Core Personal Consumption Expenditure (PCE) inflation and Fed SEP (summary of economic projections). As one can see, between 2012 and 2020 the Fed had consistently overestimated inflation. 

However, this has changed since last summer: Since then, the Fed has underestimated future inflation and in my opinion this trend will continue. 

Hence I think that there are some arguments against the claim, that inflation will be transitory. Producer prices still rose in double digits in August and those price increases are just starting to find their way into Consumer Price Inflation. 

One may argue that the inflation problem is just a problem of the United States. To whom I would reply that one should look at European Producer Price Inflation: Double Digit Year-over-Year inflation as well.  Another point is that Europe has never really opened up the economy as much as the United States and therefore I think inflation lags behind in Europe. Europe should not be too relaxed about inflation as I expect that the rise in inflation will continue in the Euro-Area.

Another thing that is striking about US-CPI in August is rent inflation. According to the CPI, rent inflation in August was 2 %, at least the way it is measured. The Fed uses so-called Owners Equivalent Rent to measure it (>than 1/3 of the CPI). However, it seems that this measure is clearly underestimating rent price increases. Let us compare it to calculations from Zillow, an American online real estate marketplace company. Zillow measures price changes for more than 100 million flats:

Hence, we could see a second wave of inflation in fall and winter, as Prof. Larry Summers writes: The Dallas Fed has shown that just looking at house prices, not the CPI indices, has a ton of predictive power with a year lag. 

The second point that speaks against the transitory narrative is that wages have risen more in the last past quarters than at any point since 1976. So, the claim that there is no inflation because one would need to see substantial wage increases, is not accurate because it is already here.

Finally there is a third argument that inflation will remain sticky: Shipping rates are still on the rise, and there is no end in sight. The Baltic Dry Index is at a 10 year all time high and continues to rise. Even more astonishing is the Harpex Index that is published by Harper Peterson Co. The index reflects the worldwide price development on the charter market for container ships. 

Additionaly, US shipping company FedEx has stated that they will increase shipping prices by 5.9 % on average in 2022. Inflation really looks transitory, right?

Which brings me to this weeks FOMC meeting. Interestingly, there was not very much of a debate at the press conference that inflation really is that transitory or not. Powell is already pushing back and not only Powell, the same is true at the other side of the great pond. 

Now inflation is a good thing. Powell said that Substantiall progress on inflation has been achieved and thus it seems to me as if the narrative changes for the fourth time within a year: At first, Powell, Lagarde and all comrades tried to assure everyone that there will not be inflation. Later, when inflation started to pick up they claimed that there is no inflation and after that they claimed that inflation is transitory and due to base effects.

Well, the base effects are not there anymore and inflation is still very high compared to inflation rates from some years ago. But hey, inflation is apparently a good thing. This is good inflation that we have created.

Some people still interpreted the FOMC as a hawkish surprise, although there was nothing new about tapering or rate hikes. Everything was fully in line with expectations. Jay Powell said that tapering will start soon. Well, if one follows the Fed, one knows that soon is a very flexible term for it. While I think that there really is a possibility for a little tapering, I think the Fed is still hoping for an excuse to keep it as little as possible. Maybe there will be another black swan that takes a possible taper of the table. Nevertheless, the Fed is continuing their buyings of US treasuries and MBS at current pace. 

One may ask - according to this weeks events - that maybe Evergrande is the black swan? Equity markets freaked out a bit on monday, as Evergrandes liquidity problem became more and more obvious. Some already talked about a Chinese Lehman moment. 

I tend to disagree (for now). The situation of the Chinese housing market has been obvious for years and there is a wide consensus that there is a bubble, in contrary to the situation in the US pre 2007 where everyone was convinced that house prices always go up (While I write this, I think about stonks always go up). I have read about those problem years ago. Finally, everyone is convinced that the PBoC will solve the problem very quickly and that the situation is contained.

However, the latest Grant-Williams things that make you go hmmm... newsletter shows another possibility: Grant sees interesting parallels between Joseph Stalin and Xi Jinping concerning their thurst for total control and power. 

Events around Jack Ma, Huarong Asset Management Chair Lai Xiaomin and the happenings around the IPO of Didi (the Chinese Uber) point to the fact, that Xi's first goal is total power. According to Grant, the Evergrande crisis may play into Xi's hands so he can get rid of opponents within the CCP and maybe has an interest that there will be a crisis. And as his lust for power is high, Xi will never let this crisis go to waste...

Without reading Grant's piece, this is a theory I would not have considered. Nevertheless, I am still full of doubts that Evergrande really becomes the Fed's Black Swan event, because as I have already wrote: Everyone knew about it...

Have a great weekend!
Fabian Wintersberger

Disclaimer: This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the blog owner and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity.