Last week the reflation trade was a bust after the Fed hinted they might hike interest rates many moons from now. This week those same trades (value stocks, commodities, natural resource stocks, etc.) popped higher on the same idea, namely than any rate hike is many moons from now. Don’t you love it?!
On the inflation front, the latest personal consumption expenditure index came in at +0.5% month-over-month in May and +3.9% year-over-year. This is the fastest rate of inflation since 1992. However, the key from a market perspective was that the month-over-month number slowed from +0.7% in April. Maybe the inflation spike is proving to be transitory the market thought.
Also arguing for the transitory theory was the fact the gains were highly concentrated in a small number of categories such as used and rental cars, hotels, and airfares, as you can see below.
Furthermore, key inputs such as used car prices seem to be seeing slower growth or outright declines. We mentioned commodities last week. This week there was the first hint that used car price appreciation might be slowing (the chart below is the Manheim used car index – who knew there was such a thing?).
And just to underscore the ‘many moons’ idea, the Fed Chairman himself emphasized how patient they are likely to be when he testified in the house earlier in the week. The key quote was:
“We will not raise interest rates pre-emptively because we fear the possible onset of inflation. We will wait for evidence of actual inflation or other imbalances.”
All of this seems a bit bizarre to most people. Is this really what the market is trading off of on a day-to-day basis? But it kinda is. At the margin, the question of whether the Fed kills the economic cycle is the big question. We know fiscal policy isn’t going to turn restrictive soon. After all, President Biden might get a $1 trillion infrastructure package through Congress this summer (although the odds are probably still 50/50). But if inflation is on the secular upswing, there is the major question of whether the Fed will react to inflation like it did during the 1970s…
…or the 1940s and 1950s. The blue line in both charts is inflation while the red line shows short-term rates, a surrogate for Fed policy.
During the war and post-war years, the Fed kept rates unusually low given the inflation backdrop to spur growth and inflate away the debt burden from the war. If we had to guess we’d say the Fed is going to try and follow the script from the 1940s. After all, how high can rates be allowed to go when the total amount of debt in the system is so high?
Charts We Found Interesting
1. Vaccination rates in the U.S. by age group.
2. The U.K. is seeing rising infection rates in younger (and unvaccinated) cohorts. To be determined what it means for school re-opening this fall.
3. While not directly related, the delta variant gains ground in China at the same time shipping costs are soaring.
4. Where capital has been invested since 1980.
5. Forecast temperatures for 5pm this coming Sunday. As high as 121F in the northern Central Valley of California, 113 and 115 in the Columbia Basin, and 104-105 in the Willamette Valley. Urgh!!
6. Europe is suffering through a heat wave as well. For example, on Wednesday Estonia recorded its hottest day in history (34.6C = 94.3F). Estonia is only 500 miles or so from the artic circle.
7. Lake Tahoe is low, but not as low as it has been. But by summer’s end it could be a different story.
8. This feels about right.
Have a good weekend.
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