It was all about inflation and central banks this week. As a matter of fact, most weeks this year have been all about inflation and central banks, at least when it comes to the markets. Urrrgh.
The inflation news was actually a bit better than expected. The headline consumer price index increased +7.1% year-over-year in November, a slowdown from +7.7% the month before. If you take out food and fuel, prices prices are up +6%.
The monthly data shows the same slowing. Prices were up just +0.1% in November after increasing +0.4% October.
Energy and goods prices were down in November while food and services were up.
At this rate inflation is on track to fall pretty significantly the next few months. The chart below shows that we could see inflation below 2% by the middle of next year if November’s pace of inflation continues.
But of course, extrapolation can be dangerous for one’s health!!
Will the Fed Get Rid of the Dots Already!!
The Fed met Tuesday and Wednesday with the latest inflation report as the backdrop. There were no real surprises at the conclusion of the meeting. As expected, they hiked rates by a half-point to get the Fed Funds rate to between 4.25% and 4.5%. They also tweaked their forecast for how high rates are likely to go - the median dot now shows rates peaking at 5.125% late next year, up 50bp from the September projections (the green line in the chart below).
During his press conference Chairman’s Powell stressed that there was “more work to do” to bring inflation down. He was cautious in celebrating the softer CPI number and repeatedly pointed to the imbalance in the labor market. He did, however, appear to leave the door open to downshifting to 25bp hikes beginning with the next meeting in early February.
Look at the dot plot chart above one more time. See how rates are projected to fall in 2024 and 2025? Should we give any credence to this projection?
In a word – no.
Just look at dot plots from years past. If you go back to this date in 2020 you can see that the Fed didn’t think they’d hike rates in 2021, 2022, or 2023.
Ok, COVID was playing havoc with things at the end of 2020. They can be forgiven for fluffing the call then.
But how about their view at the end of 2021? The chart below shows the dot plot from 12/15/2021. The Fed thought the funds rate would close 2022 at just under 1%, and get to 1.5% by the end of 2023. Not even close.
This dot plot thing needs to go away. It isn’t that the Fed is dumb….projections are tough. Most big investment banks have similar projections to the Fed’s. But the intent of publishing the dot plot is to make monetary policy more transparent. But is it really? The Fed will always be data dependent. If the data changes they change policy. And more importantly, the Fed will always be a political animal. The political winds are blowing in the direction of a need to do something about inflation. The Fed can’t ignore this and you can’t incorporate political necessities into a simple graph.
German Bonds Crack
Sick of all the talk about central banks yet? Yea, me too. But just one more hit.
The European Central Bank also met this week and they hiked rates by the expected 50bps as well. However, they really surprised the pundits. ECB president Christine Lagarde stunned onlookers as she said it was “obvious” to expect 50 basis points rate hikes for a period of time. February was “likely”, but a 50 bps hike was possible at both the March and April meetings. She also said the ECB would start Quantitative Tightening in March at a pace of €15 billion per month.
Well, it might be obvious to her, but few others thought so. For example, German bond investors were caught majorly offside – yields spiked by the third largest amount since 1990.
Europe has an inflation problem for sure. But as in the U.S., the monthly rate of change is slowing. Why so hawkish now is the unanswered question?
The ECB has an unfortunate history of getting really excited about hiking rates at exactly the wrong time. Back in 2011 then ECB president Trichet hiked rates twice exactly when the wheels were coming off the European Union. Yea, that wasn’t great timing.
Is history repeating? Only time will tell, but it will sure be embarrassing if the ECB is cutting rates by the middle of next year.
Charts We Found Interesting
1. War in Europe, constrained oil supplies….and crude prices are down for the year?
2. It’s the same for gasoline prices.
3. The decline in the stock market this year has resulted in better values….but large-caps are still pretty rich. Of course, this number is inflated by the large tech names.
4.The National Association of Realtors has 1,598,117 members, equal to 1% of the total U.S. labor force.
5. The administration is going to start filling the Strategic Petroleum Reserve in the new year. You have to be thinking supply problems for 2023 given the lack of investment in the sector.
6. Emissions in the U.S. split out between power generation (-33% since 2000) and transportation (-4%).
7. Speaking of emissions from transportation – the economics of launching stuff into space has been revolutionized by SpaceX.
8. How the world has changed since 1970 – and not in a good way.
Have a good weekend.
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