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Wall Street Reacts To Today’s Huge CPI Miss

Wall Street Reacts To Today’s Huge CPI Miss

“Remember that one month does not make a trend. But also remember that every trend starts with…

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Wall Street Reacts To Today's Huge CPI Miss

“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."
Tyler Durden Wed, 08/10/2022 - 10:00

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Economics

Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Roughly 60% of Americans say they’re living paycheck to paycheck -…

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Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Roughly 60% of Americans say they're living paycheck to paycheck - a figure which hasn't budged much overall from last year's 55% despite inflation hitting 40-year highs, according to a recent LendingClub report.

Even people earning six figures are feeling the strain, with 45% reporting living paycheck to paycheck vs. 38% last year, CNBC reports.

"More consumers living paycheck to paycheck indicates that many are continuing to lose their financial stability," said LendingClub financial health officer, Anuj Nayar.

The consumer price index, which measures the average change in prices for consumer goods and services, rose a higher-than-expected 8.3% in August, driven by increases in food, shelter and medical care costs.

Although real average hourly earnings also rose a seasonally adjusted 0.2% for the month, they remained down 2.8% from a year ago, which means those paychecks don’t stretch as far as they used to. -CNBC

Meanwhile, Bank of America found that 71% of workers say their income isn't keeping pace with inflation - resulting in a five-year low in terms of financial security.

"It is no secret that prices have been increasing for everyday Americans — not only in the goods and services they purchase but also in the interest rates they’re paying to fund their lives," said Nayar, who noted that people are relying more on credit cards and carry a higher monthly balance, making them financially vulnerable. "This can have detrimental consequences for someone who pays the minimum amount on their credit cards every month."

According to an Aug. 30 report from the Federal Reserve Bank of New York, credit card balances increased by $46 billion from last year, becoming the second-biggest source of overall debt last quarter.

And as Bloomberg noted last month, more US consumers are saddled with credit card debt for longer periods of time. According to a recent survey by CreditCards.com, 60% of credit card debtors have been holding this type of debt for at least a year, up 50% from a year ago, while those holding debt for over two years is up 40%, from 32%, according to the online credit card marketplace.

And while total credit-card balances remain slightly lower than pre-pandemic levels, inflation and rising interest rates are taking a toll on the already-stretched finances of US households.

About a quarter of respondents said day-to-day expenses are the primary reason why they carry a balance. Almost half cite an emergency or unexpected expense, including medical bills and home or car repair.

The Federal Reserve is likely to raise interest rates for the fifth time this year next week. Credit-card rates are typically directly tied to the Fed Funds rate, and their increase along with a softening economy may lead to higher delinquencies. 

Total consumer debt rose $23.8 billion in July to a record $4.64 trillion, according to data from the Federal Reserve. -Bloomberg

The Fed's figures include credit card and auto debt, as well as student loans, but does not factor in mortgage debt.

Tyler Durden Tue, 10/04/2022 - 20:25

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Spread & Containment

Plunging pound and crumbling confidence: How the new UK government stumbled into a political and financial crisis of its own making

Liz Truss took over as prime minister with an ambitious plan to cut taxes by the most since 1972 – investors balked after it wasn’t clear how she would…

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The hard hats likely came in handy recently for Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng. Stefan Rousseau/Pool Photo via AP

The new British government is off to a very rocky start – after stumbling through an economic and financial crisis of its own making.

Just a few weeks into its term on Sept. 23, 2022, Prime Minister Liz Truss’ government released a so-called mini-budget that proposed £161 billion – about US$184 billion at today’s rate – in new spending and the biggest tax cuts in half a century, with the benefits mainly going to Britain’s top earners. The aim was to jump-start growth in an economy on the verge of recession, but the government didn’t indicate how it would pay for it – or provide evidence that the spending and tax cuts would actually work.

Financial markets reacted badly, prompting interest rates to soar and the pound to plunge to the lowest level against the dollar since 1985. The Bank of England was forced to gobble up government bonds to avoid a financial crisis.

After days of defending the plan, the government did a U-turn of sorts on Oct. 3 by scrapping the most controversial component of the budget – elimination of its top 45% tax rate on high earners. This calmed markets, leading to a rally in the pound and government bonds.

As a finance professor who tracks markets closely, I believe at the heart of this mini-crisis over the mini-budget was a lack of confidence – and now a lack of credibility.

A looming recession

Truss’ government inherited a troubled economy.

Growth has been sluggish, with the latest quarterly figure at 0.2%. The Bank of England predicts the U.K. will soon enter a recession that could last until 2024. The latest data on U.K. manufacturing shows the sector is contracting.

Consumer confidence is at its lowest level ever as soaring inflation – currently at an annualized pace of 9.9% – drives up the cost of living, especially for food and fuel. At the same time, real, inflation-adjusted wages are falling by a record amount, or around 3%.

It’s important to note that many countries in the world, including the U.S. and in mainland Europe, are experiencing the same problems of low growth and high inflation. But rumblings in the background in the U.K. are also other weaknesses.

Since the financial crisis of 2008, the U.K. has suffered from lower productivity compared with other major economies. Business investment plateaued after Brexit in 2016 – when a slim majority of voters chose to leave the European Union – and remains significantly below pre-COVID-19 levels. And the U.K. also consistently runs a balance of payments deficit, which means the country imports a lot more goods and services than it exports, with a trade deficit of over 5% of gross domestic product.

In other words, investors were already predisposed to view the long-term trajectory of the U.K. economy and the British pound in a negative light.

An ambitious agenda

Truss, who became prime minister on Sept. 6, 2022, also didn’t have a strong start politically.

The government of Boris Johnson lost the confidence of his party and the electorate after a series of scandals, including accusations he mishandled sexual abuse allegations and revelations about parties being held in government offices while the country was in lockdown.

Truss was not the preferred candidate of lawmakers in her own Conservative Party, who had the task of submitting two choices for the wider party membership to vote on. The rest of the party – dues-paying members of the general public – chose Truss. The lack of support from Conservative members of Parliament meant she wasn’t in a position of strength coming into the job.

Nonetheless, the new cabinet had an ambitious agenda of cutting taxes and deregulating energy and business.

Some of the decisions, laid out in the mini-budget, were expected, such as subsidies limiting higher energy prices, reversing an increase in social security taxes and a planned increase in the corporate tax rate.

But others, notably a plan to abolish the 45% tax rate on incomes over £150,000, were not anticipated by markets. Since there were no explicit spending cuts cited, funding for the £161 billion package was expected to come from selling more debt. There was also the threat that this would be paid for, in part, by lower welfare payments at a time when poorer Britons are suffering from the soaring cost of living. The fear of welfare cuts is putting more pressure on the Truss government.

a man in a brown stocking hat inspects souvenirs near a bunch of UK flags and other trinkets
The cost of living crisis in the U.K. has everyone looking for deals where they can. AP Photo/Kirsty Wigglesworth

A collapse in confidence

Even as the new U.K. Chancellor of the Exchequer Kwasi Kwarteng was presenting the mini-budget on Sept. 23, the British pound was already getting hammered. It sank from $1.13 the day before the proposal to as low as $1.03 in intraday trading on Sept. 26. Yields on 10-year government bonds, known as gilts, jumped from about 3.5% to 4.5% – the highest level since 2008 – in the same period.

The jump in rates prompted mortgage lenders to suspend deals with new customers, eventually offering them again at significantly higher borrowing costs. There were fears that this would lead to a crash in the housing market.

In addition, the drop in gilt prices led to a crisis in pension funds, putting them at risk of insolvency.

Many members of Truss’ party voiced opposition to the high levels of borrowing likely necessary to finance the tax cuts and spending and said they would vote against the package.

The International Monetary Fund, which bailed out the U.K. in 1976, even offered its figurative two cents on the tax cuts, urging the government to “reevaluate” the plan. The comments further spooked investors.

To prevent a broader crisis in financial markets, the Bank of England stepped in and pledged to purchase up to £65 billion in government bonds.

Besides causing investors to lose faith, the crisis also severely dented the public’s confidence in the U.K. government. The latest polls showed the opposition Labour Party enjoying a 24-point lead, on average, over the Conservatives.

So the government likely had little choice but to reverse course and drop the most controversial part of the plan, the abolition of the 45% tax rate. The pound recovered its losses. The recovery in gilts was more modest, with bonds still trading at elevated levels.

Putting this all together, less than a month into the job, Truss has lost confidence – and credibility – with international investors, voters and her own party. And all this over a “mini-budget” – the full budget isn’t due until November 2022. It suggests the U.K.‘s troubles are far from over, a view echoed by credit rating agencies.

David McMillan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Economics

Roubini: The Stagflationary Debt Crisis Is Here

Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to…

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Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. US and global equities are already back in a bear market, and the scale of the crisis that awaits has not even been fully priced in yet.

For a year now, I have argued that the increase in inflation would be persistent, that its causes include not only bad policies but also negative supply shocks, and that central banks’ attempt to fight it would cause a hard economic landing. When the recession comes, I warned, it will be severe and protracted, with widespread financial distress and debt crises. Notwithstanding their hawkish talk, central bankers, caught in a debt trap, may still wimp out and settle for above-target inflation. Any portfolio of risky equities and less risky fixed-income bonds will lose money on the bonds, owing to higher inflation and inflation expectations.

How do these predictions stack up? First, Team Transitory clearly lost to Team Persistent in the inflation debate. On top of excessively loose monetary, fiscal, and credit policies, negative supply shocks caused price growth to surge. COVID-19 lockdowns led to supply bottlenecks, including for labor. China’s “zero-COVID” policy created even more problems for global supply chains. Russia’s invasion of Ukraine sent shockwaves through energy and other commodity markets. And the broader sanctions regime – not least the weaponization of the US dollar and other currencies – has further balkanized the global economy, with “friend-shoring” and trade and immigration restrictions accelerating the trend toward deglobalization.

Everyone now recognizes that these persistent negative supply shocks have contributed to inflation, and the European Central Bank, the Bank of England, and the US Federal Reserve have begun to acknowledge that a soft landing will be exceedingly difficult to pull off. Fed Chair Jerome Powell now speaks of a “softish landing” with at least “some pain.” Meanwhile, a hard-landing scenario is becoming the consensus among market analysts, economists, and investors.

It is much harder to achieve a soft landing under conditions of stagflationary negative supply shocks than it is when the economy is overheating because of excessive demand. Since World War II, there has never been a case where the Fed achieved a soft landing with inflation above 5% (it is currently above 8%) and unemployment below 5% (it is currently 3.7%). And if a hard landing is the baseline for the United States, it is even more likely in Europe, owing to the Russian energy shock, China’s slowdown, and the ECB falling even further behind the curve relative to the Fed.

Are we already in a recession? Not yet, but the US did report negative growth in the first half of the year, and most forward-looking indicators of economic activity in advanced economies point to a sharp slowdown that will grow even worse with monetary-policy tightening. A hard landing by year’s end should be regarded as the baseline scenario.

While many other analysts now agree, they seem to think that the coming recession will be short and shallow, whereas I have cautioned against such relative optimism, stressing the risk of a severe and protracted stagflationary debt crisis. And now, the latest distress in financial markets – including bond and credit markets – has reinforced my view that central banks’ efforts to bring inflation back down to target will cause both an economic and a financial crash.

I have also long argued that central banks, regardless of their tough talk, will feel immense pressure to reverse their tightening once the scenario of a hard economic landing and a financial crash materializes. Early signs of wimping out are already discernible in the United Kingdom. Faced with the market reaction to the new government’s reckless fiscal stimulus, the BOE has launched an emergency quantitative-easing (QE) program to buy up government bonds (the yields on which have spiked).

Monetary policy is increasingly subject to fiscal capture. Recall that a similar turnaround occurred in the first quarter of 2019, when the Fed stopped its quantitative-tightening (QT) program and started pursuing a mix of backdoor QE and policy-rate cuts – after previously signaling continued rate hikes and QT – at the first sign of mild financial pressures and a growth slowdown. Central banks will talk tough; but there is good reason to doubt their willingness to do “whatever it takes” to return inflation to its target rate in a world of excessive debt with risks of an economic and financial crash.

Moreover, there are early signs that the Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. In addition to the disruptions mentioned above, these shocks could include societal aging in many key economies (a problem made worse by immigration restrictions); Sino-American decoupling; a “geopolitical depression” and breakdown of multilateralism; new variants of COVID-19 and new outbreaks, such as monkeypox; the increasingly damaging consequences of climate change; cyberwarfare; and fiscal policies to boost wages and workers’ power.

Where does that leave the traditional 60/40 portfolio? I previously argued that the negative correlation between bond and equity prices would break down as inflation rises, and indeed it has. Between January and June of this year, US (and global) equity indices fell by over 20% while long-term bond yields rose from 1.5% to 3.5%, leading to massive losses on both equities and bonds (positive price correlation).

Moreover, bond yields fell during the market rally between July and mid-August (which I correctly predicted would be a dead-cat bounce), thus maintaining the positive price correlation; and since mid-August, equities have continued their sharp fall while bond yields have gone much higher. As higher inflation has led to tighter monetary policy, a balanced bear market for both equities and bonds has emerged.

But US and global equities have not yet fully priced in even a mild and short hard landing. Equities will fall by about 30% in a mild recession, and by 40% or more in the severe stagflationary debt crisis that I have predicted for the global economy. Signs of strain in debt markets are mounting: sovereign spreads and long-term bond rates are rising, and high-yield spreads are increasing sharply; leveraged-loan and collateralized-loan-obligation markets are shutting down; highly indebted firms, shadow banks, households, governments, and countries are entering debt distress.

The crisis is here.

Tyler Durden Tue, 10/04/2022 - 17:25

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