Ok, here comes CPI.
If this were any other week, this would probably be the subject of considerable debate, but given everything else that’s going on, it’s gotten lost in the shuffle a bit.
As Bloomberg reminds you, retail investors have been piling into TIPS ETFs of late in an apparent effort to get out ahead of things.
Obviously, today’s data won’t meaningfully affect the Fed’s decision calculus for the June meeting, but it will still be watched for signs of nascent price pressures and will feed into market expectations for the rate path going forward. Here’s what Goldman said going in on core:
Core CPI: GS +0.19%mom, consensus +0.2%mom, last +0.1%mom. We estimate a 0.19% increase in May core CPI (mom sa), which would boost the year-over-year rate by one tenth to 2.2%. We view the risks to the year-over-year rate as skewed to the upside (i.e. 2.3% is more likely than 2.1%). Our forecast reflects a boost in the recreation category from the Amazon Prime price increase, as well as a rebound in airfares and second-derivative improvement in the new and used cars category. We also expect firm increases in owner’s equivalent rent and medical services. We look for a 0.18% increase in headline CPI, reflecting modest expected inflation in the food and energy categories.
As usual, you want just enough upbeat news here to underscore the reflation narrative and not enough “good” news for “good” news to be “bad” news, where “bad” news entails a print hot enough to spook the Fed into tightening more aggressively.
Estimates and priors
- US CPI MoM, est. 0.2%, prior 0.2%
- US CPI Ex Food and Energy MoM, est. 0.2%, prior 0.1%
- US CPI YoY, est. 2.8%, prior 2.5%
- US CPI Ex Food and Energy YoY, est. 2.2%, prior 2.1%
- US CPI Index NSA, est. 251.6, prior 250.5
- US CPI Core Index SA, est. 256.9, prior 256.5
- Real Avg Weekly Earnings YoY, prior 0.42%
- Real Avg Hourly Earning YoY, prior 0.2%
- CPI rose 0.2% vs est. 0.2%, according to the BLS.
- Forecast range from up 0.1% to up 0.5% from 70 estimates
- Ex. food, energy m/m up 0.171%; est. up 0.2%
- CPI Y/y rose 2.8%, matching estimate
The Y/Y print there represents the swiftest pace since 2012:
This seems like a good time to reprint the following from our good friend Kevin Muir, The Macro Tourist:
The market seems to have finally caught on.Inflation is coming. In fact, it’s already here. And it will get a lot worse.
Instead of writing yet another piece reiterating my beliefs about why inflation will be a problem in the coming decades, I have decided to explore how market inflation expectations have changed over the past couple of years.
At the start of 2016, the market was pricing in a 1% 5-year breakeven inflation rate. That meant inflation had to average less than 1% for the next five years for nominal bonds to outperform TIPS (Treasury Inflation Protected Securities). Stop and think about that for a moment. The Federal Reserve has an inflation target of 2%. Yet the market did not believe they could achieve an inflation rate of even half their target.
The three Ds (deflation, demographics, and debt) were on everyone’s lips. It made little sense to invest in inflation-protected securities when everyone knew there could be no inflation.
Well, guess what? That 1% 5-year breakeven rate has now risen to 2%.
Today the market is expecting the Federal Reserve to hit its 2% inflation target.
But the most interesting part of this higher repricing of inflation expectations? Instead of worrying about inflation getting away from the Fed, the market is more worried about a short-term spike in inflation than a sustained long-term rise.
To illustrate this, let’s look at the US 2-year and 30-year breakeven inflation rates.
The 2-year breakeven inflation rate has risen from 0% in September 2015 to almost 2% today. During this same period, the 30-year breakeven inflation rate has stayed steady at approximately 2%, finishing that same period about an eighth of a percent higher.
The vast majority of the inflation expectation rise has been centered at the front end of the curve!
Here is another way to think about it. Instead of looking at breakeven inflation rates, let’s look at the yield curve of TIPS securities. This is “real yield” – the rate which an investor will earn after inflation.
Look at the curve two years ago – it was steep with an investor “earning” almost 100 negative basis points at the 1-year term and 75 basis points at the 30-year term. That was a spread of 175 basis points. Contrast that to today when the front end is roughly the same as the long end. Not only that, but the curve is actually inverted at the front end.
What does this mean?
Although investors have priced in increased inflation expectations, there are few concerns about long-term inflation rising in a meaningful way. The market has acknowledged that the economy is about to experience a short-to-medium-term uptick in inflation, but so far, has almost no worry that inflation will get away from the Federal Reserve over the long run.
Well, bought from them. I love the idea of owning long-term breakeven inflation rates. The market is still not convinced that inflation is the real worry. Although market participants grudgingly accept that inflation is headed higher, they have yet to acknowledge the potential of this becoming a serious problem. They still think the Fed has got this under control.
This is my prediction: before this is all through, investors will overpay for the longest, most leveraged inflation protection they can buy. There will be 3-times inflation ETFs created that attract hundreds of millions of dollars of assets. At that point, we will think about selling. Until then, be thankful for their skepticism.