“Remember that one month does not make a trend. But also remember that every trend starts with one month.” - Leon Brittan
For a look at just how big of a surprise today's CPI miss (which we said would be a miss in our preview), look no further than the market where it's a sea of red with every asset class soaring (except energy)...
... and where the plight of the shorts - which these days is most hedge funds - can be summarized with one image:
Why this tremendous market reaction, where - when one strips away the rhetoric - all we have seen is one month's drop in energy prices, which will only rise now that the market is starting to anticipate a Fed pivot.
Bloomberg asks a similar question, namely "what’s behind the surprising slowdown in July?" and notes that according to a new Bloomberg Economics model, US inflation decomposes into four factors: supply, demand, energy prices and monetary policy.
The model found that lower energy costs and a slightly tighter Fed stance were the main drivers of the deceleration to 8.5% last month.
At the same time, sizzling demand paired with supply constraints continue to put upward pressure on inflation. With these last two factors harder to contain, Bloomberg writes that "the Fed has a tough task ahead of it and will likely need to be more hawkish then currently expected", or in other words, echoing what we said yesterday when we warned that "a miss will make Powell's life extremely hard."
Why? Well, here is a good thread summary from Dan Alpert:
And the answer is: Headline: ZERO M/M; Core: 0.3%
The end is nigh!
That headline reading was with food UP 1.1% in July, offset by energy falling -4.9% on the month. (Energy commodities -7.6%)
Core commodities (goods) only rises 0.2% on the month as supply chains reopen and production inventories build to backlog. On the services side, the price rise falls to 0.4% driven by a -0.5 decline in transportation services in July.
The shelter rise moderates a bit to +0.5% M/M on the back of a 2.7% monthly decline in lodging, which fell for the second straight month after pandemic reopening demand and supply squeezes (this will accelerate into the fall).
Rent and Owners Equivalent Rent of Primary Residences, the primary drivers of core inflation, remain high at 0.7% and 0.6% M/M respectively. But that is lagging data and the housing market has already been thrown into decline by Fed interest rate hikes and building oversupply.
Housing is, these days, the principal channel through which Fed monetary policy operates (the mortgage market). >>
While Fed hikes are not responsible for inflation slowing in this report (the prior inflation itself - "the cure for high prices is high prices", opening supply chains and lower global energy prices were), higher interest rates will have a huge impact on housing (and CPI) soon.
In October of last year, before Omicron and the Ukraine War disturbed pricing metrics around the world, I noted that inflation would be a first half of 2022 story (I said it would subside by Q2, but the foregoing events got in the way).
Yet here we are.
While these M/M sectoral declines will not be repeated every month, we will see housing costs gradually subside for sure, core goods stabilize and consumer purchases driven most by pandemic reopening "revenge spending" see material price retrenchment as inventories rebuild.
The only real wild cards are exogenous (not demand driven) supply risks associated with oil and gas, and their bleed over impact on food (think fertilizer and food transportation) costs.
All in all, this report is as I expected and the trend is reorienting itself.
We are at the point where the annual (Y/Y) CPI figures cease to have meaning. Prices are what they are now, as are wages and incomes. The only issue is where they go in the future. And that is not a function of expectations, it is the discipline of supply and demand.
One last data point FWIW: CPI All Items less Shelter fell by -0.3% in July.
While we are confident that those who don't actually have a corporate charge card will disagree with Dan's cheerful take on today's inflation print, there was another reason for the market's euphoric reaction - the chart below from Bloomberg shows the breadth of inflation. The July reading of 71.8 is saying that 71.8% percent of the CPI basket is increasing in price at more than a 4% on an annualized basis from the MoM data, which represents relief for the Fed after June’s high of 74.8%.
What do other market watchers and strategists think? Below we summarize a handful of hot takes from across Wall Street:
- Peter Tchir, chief strategist at Academy Securities: "Slightly better than expected inflation across the board. Initial reaction lower yields, steeper curves (which I like). Higher stocks/risk assets - expected based on numbers, but 1) not sure number beat the whisper; 2) still high enough Fed not completely out of picture, which may lead us back to fixating on recession, inventories, semiconductors, warnings, etc. So fading this on risk side of the equation"
- Seema Shah, chief strategist at Principal Global Investors: “This is a textbook bear market rally -- technicals and sentiment drove the upturn and momentum is carrying it for now. Markets have become overly optimistic about the Fed outlook and even the economy. But as we get into Q4, earnings growth will show clear signs of struggles and inflation will be easing only slowly, giving markets an important reminder the further rate hikes are absolutely necessary.”
- Peter Boockvar, chief investment officer at Bleakley Financial Group: “We know there is another CPI figure, along with a jobs number before the Fed meets again. I’ll say again that they will be going 50 bps in September and I doubt much past that.”
- Eric Theoret, global macro strategist at Manulife Investment Management: "I'll be watching breakevens, and the challenge from here will be for markets to not celebrate too much and declare victory... Breakevens tend to be well correlated to market sentiment and the price of crude more specifically. A weaker USD and risk on tone would support the price of oil and lift breakevens, pulling them away from target. This is not something that markets or the Fed ultimately want.”
- Neil Dutta, head of US economic at Renaissance Macro: “This data point will fuel talk of a policy pivot. But, for me, the issue really does boil down to the labor market. Short-term inflation expectations and gasoline prices were the story in May and June. That’s not the story now. Wage growth is running red hot and absent a turn around in productivity this will ultimately fuel higher prices.”
- Anna Wong, Bloomberg chief economist: "Both headline and core CPI inflation were surprisingly soft in July, but with recent wage and productivity data signaling prices pressures ahead, the Federal Reserve is unlikely to step back from the inflation fight just yet. Another soft print is likely in August as gasoline prices have continued to decline."
- Ira Jersey, Bloomberg strategist: “Our analysis shows that the lower-volatility (read sticky) components of core CPI may have peaked in July, but the medium-volatility sector continues to jump higher. If the low-volatility cluster stabilizes at this higher level, these combined trends may keep core CPI underpinned and the Fed hawkish.... The better-than-expected core CPI print will be a strong positive for the Treasury market, particularly the long end, so the knee-jerk reaction is unsurprising. The strong steepening of the curve may not last, however, as the better-than-expected core still doesn’t mean it will fall. In fact, although better than expected, the core may be sticker than the market seems to be anticipating.”
- Ellen Zentner, Morgan Stanley economist: "Fed officials are unlikely to see this report as a signal to deviate from their steep tightening path we foresee through the end of this year. That said, this report makes a 50 basis points more likely at the September meeting rather than 75, but a lot will depend on the August CPI release next month.”
- Ian Lyngen, rates strategist at BMO Capital Markets: "post-CPI steepening in 2/10’s to around -40bps is a reentry point to add to a core flattener and expect that the incoming Fed-speak will emphasize the idea that the Fed will need to see more than one month of data for confirmation inflation has, in fact, peaked.”
- Ellen Gaske, G10 economist at PGIM Fixed Income: “The weaker-than-expected CPI print suggests the Fed could adopt a more cautious pace of tightening going forward.”
- Dennis DeBusschere, founder of 22V Research: "the report is obviously very positive for markets on the day -- rates are lower, rate-hike expectations are lower and worries about a too-hot CPI with very strong employment reduced.”
- Michael Pond, head of inflation strategy at Barclays: “This is a necessary print for the Fed, but it’s not sufficient. We need to see a lot more. You can think about this print sort of like the weather: it’s better today than it has been over the past few days. But it’s still summer. There’s still a lot of humidity.”
- Matt Maley, chief market strategist at Miller Tabak: “Some people were starting to think that we could get a 75 basis point hike in September or even a mid-meeting hike. This weaker than expected CPI number takes that off the table. In fact, it might even cause some people to look for a pause from the Fed.”
- Victoria Greene, chief investment officer at G Squared: “While this is to be celebrated, 8.5% inflation is still well above what the Fed wants to see. 50-75bps are still on the table for September, and more data will come in by that point."
- Jim Paulsen, chief investment strategist at the Leuthold Group: “Wow, finally the anecdotal evidence that inflation was easing has finally showed up in a mainstream inflation report. The Fed is rapidly losing its case for further tightening and this report reinforces for investors that either a new easing cycle has already begun or we are getting very close to one.”
- Han Hatzius, Goldman Sachs chief economist: "July core CPI rose by 0.31% month-over-month, below expectations and the slowest monthly pace since September. Declines in airfares and used car prices contributed to the slowdown, and we also note a sequentially slower but still elevated pace of shelter inflation."