Another solid week for the global equity markets, and the relentless push higher continues, especially for the tech/growth names. I still can’t get my head around the chart below – the market cap for Apple almost equals all 2000 companies in the small-cap index??!!
In terms of economic statistics, the housing data was probably the most interesting. Oh, and the Fed officially moved the goal posts.
Safe as Houses?
I guess when people are stuck at home they watch House Hunters and check out Zillow. That would explain the following: Economists thought new homes sales would be up 1.3% in July, but as it turned out they jumped 14% to a 13-year high.
That’s not a U-shaped recovery. It’s not even a V. More like a rocket ship. Geesh.
Now national home prices aren’t quite as buoyant, but the graph still slopes up and to the right. The national index is 18.1% above the 2006 bubble peak, while a composite of 20 markets is 8.3% above the bubble peak.
Of course, this doesn’t mean everywhere is booming. The San Francisco Metro area is suffering through some pain. The chart below shows the share of homes currently on the market with price reductions. Just a few day ago roughly a quarter of all homes had seen a price cut. This time last year it was roughly 11%.
But in general housing is in solid shape. So much so the cost to build a new home is rising rapidly. Lumber futures were under $300 back in April. Today they are hovering around $900. Mills can’t keep up with demand.
As long as rates stay low housing should stay well supported. And short-term rates at least are going to stay low for a very long time.
Chairman Powell Kills The Philips Curve
If you cast your mind back to the dark recesses of economic history, say late 2015, you might recollect a popular idea at the time. It went something like this. If unemployment levels got low enough it would probably trigger an outbreak of inflation. And one of the few reasons for the Fed’s existence was to snuff this inflation out before things got out of hand. So, in late 2015 they started raising rates preemptively – there wasn’t an inflation problem, but they thought we’d see one soon. They were believers in the chart below, the so-called Phillips Curve.
But remember, in 2015 there wasn’t an inflation problem. Look at the chart below. In late 2015 both headline and core inflation were way below the 2% target. Again, the Fed was preemptive. Their playbooks said it was coming soon.
Well, as it turned out inflation didn’t do much at all. As a matter of fact, they raised rates so much that in 2018 they basically triggered a bear market (although they didn’t trigger a recession).
Now maybe this was a good idea. Take some steam out of soaring asset prices? Maybe the Fed’s job is really to simply take the punch bowl away before people get too carried away. After all, they were criticized for not proactively doing something about both the tech bubble in 1999 and the housing bubble in 2006/2007.
Well, the Fed’s job as ‘downer in chief’ is officially over.
Average Inflation Targeting
The Fed is now all about ‘average inflation targeting’ (I can’t even bring myself to type AIT, but I guess I just did). What does this mean? Well, as it stands now, if the economy experiences a year of 1% inflation, the Fed does not alter the target for the following year. It was 2%, and after a year of 1% inflation, it would still be 2%.
With ‘average inflation targeting’ the Federal Reserve would target the 2% level over a certain period. For example, if that period was two years, then in our previous example, the Federal Reserve would target 3% in the second year to get the average to 2% over the two-year period.
Yawn, right? But this is actually a big deal.
How has the Fed done in hitting their 2% inflation target? The chart below shows the amount the PCE Inflation rate was above or below their 2% target throughout the years. Basically, they stink at hitting their target, especially over the last few years.
Another way to show this is to show the absolute price trends for both the target inflation rate and the actual rate since 2008.
What this is telling us is that prices are roughly 8% lower than they should be under an ‘average inflation target’ regime. And this doesn’t refer to asset prices. This refers to food, healthcare costs, computers, and everything else that is lumped into the inflation calculation. So will the Fed allow 3% or 4% inflation to catch up? If 4% is ok, why not 6%? We aren’t really sure about the answers because the Fed didn’t say. They probably don’t know themselves.
But the key point is that the Fed has gone from the idea that they need to preemptively snuff out inflation before it returns to sort of spiking the punch bowl to get the party going.
But we should be clear about one thing. If the last few years has taught us anything, the Fed can’t by itself make inflation. Milton Friedman was famous for saying that ‘inflation is always and everywhere a monetary phenomenon.’ Well, not this last decade. Without fiscal stimulus, Central Banks can say all they want about their willingness to accept higher future inflation, but it won’t change a thing!
All that ‘average inflation targeting’ does is change the reaction function to potential future inflation. The Fed will be slow to hike rates. They will probably be more tolerant of asset bubbles (no more irrational exuberance speeches). And fiscal policy is really the only game in town now.
Charts We Found Interesting
1. The critical distinction between first and second waves: much lower mortality rates this time around (orange line below). Why? Speculation is younger cohort of more recent infections, and use of anti-coagulants, steroids (Dexamethasone) and other treatments to reduce stress on vascular and pulmonary systems in hospitalized patients.
2. I didn’t realize how much Arizona’s numbers have come down in recent weeks.
3. Still the most important chart for the U.S. economy. It is remarkable how much incomes have been boosted through expanded unemployment benefits. The orange line is due to roll over soon seeing as only five states are following President Trump’s plan for extended benefits.
4. Money supply growth in the U.S. versus Europe. Not even close!!
5. After ‘average inflation targeting’ was announced inflation expectations popped higher. This means that real bond yields fell to all-time lows.
6. Last week’s retails sales number had some interesting statistics buried within it. As you would expect, e-commerce sales are soaring.
7. But e-commerce sales are still only 15.1% of total retail sales. I had to check this twice to make sure it is right, but apparently it is.
8. If that 15.1% is headed towards 20%, 30%, or 40%, this list is going to get a lot longer.
Have a good weekend.
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