Market Recap


It’s all about inflation and earnings, earnings and inflation, oh, and what the Fed will do (or what can they do) about inflation. Markets sew saw on the latest data point or comment from a Fed talking head. Combine that with low liquidity over the summer months, and the stage is set for volatile back-and-forth trading.


The main event this week was obviously the Consumer Price Inflation (CPI) report. It was expected to come in hot, and it did. The headline number was up over +9% while core prices were up close to +6%.



No real surprises here. What stood out more was the fact that the month-over-month change accelerated in June.



There was a hope that this might have slowed given the fall in commodity prices lately. After all, gasoline prices are well off their highs:




As are pretty much all major commodity prices:



And inflation expectations are pretty subdued. The bond market is pricing in just 2% inflation over the next ten years.



However, there is a real fear that inflation will prove stubborn over the coming months. Stephen Gallagher at SocGen noted that the main concern are rental prices: “The problem is that rents are sticky…Headline inflation rates should converge toward core as energy prices retreat [but] rent prices are far less volatile, and historically, a rising unemployment rate is needed to soften rent.”


As you can see below, rental prices have soared as unemployment rates have fallen, and rents make up roughly 30% of the CPI basket.



His contention is that to get rents down you need to get unemployment up, and it’s tough to do that without triggering a recession. Hence the renewed inversion on the 10/2 yield curve.



All eyes are now on the Fed meeting on July 26th and 27th. After the CPI report came out the market started to immediately price in a full 100bps rate hike. By Friday the betting had backed off, placing the odds of a 100bps hike at just 31%.



In reality no one has good read on the trajectory of inflation over the coming months. The Yeats line seems appropriate: “The best lack all conviction while the worst are full of passionate intensity.” So, we are probably in for volatile back-and-forth trading for the next seven days until the Fed meeting. But for the markets to bottom on a durable basis we are going to have to see inflation come off the boil.


And on this matter, simply less bad news would be good. If you go back to 1973 and 1974, you can see that the S&P (yellow line below) basically put in a low the same day inflation (white line) peaked. The absolute number tied to inflation didn’t really matter then – all that counted was that it was headed lower.



Charts We Found Interesting


1. Canada went big with their rate move this week – a full 100bps hike to bring rates to 2.5%.



2. Will this finally burst the long boom in Canadian housing prices? After all, valuations are off the charts north of the border.



3. This could be the key to inflation outlook – chicken wings are off 38% from their high. Apparently there’s an index for such things.



4. Soaring food and energy prices are causing havoc in some frontier markets. Who is most a risk financially?



5. “That’s not a knife…..that’s a knife”



6. The Euro’s the cheapest it’s been in twenty years….



7. …but travel chaos is also the worst it’s been in who knows how long…



8. …oh, and early next week a large swath of southern England, northern France, the Netherlands, and Belgium could see temperatures as much as 20 C above normal…No thanks!!





Have a good weekend.




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