It’s probably time to give the wet-behind-the-ears 30-something perma-bulls of Wall Street a break. After all, they have never experienced hard times, and now they get an old duffer like Ed Hyman, Chairman of Evercore-ISI, telling them that the Fed has already way over-tightened and needs to “pause” forthwith.
What’s especially galling about Hyman’s bubblevision chatter this AM is that it was based on a piece of nonsense of the kind that never stops wafting from the financial sickbeds of Wall Street. To wit, he claimed that the “effective” Fed funds rate is actually 7%, adjusted for QT (quantitative tightening).
Oh, c’mon. The Fed’s teensy-tiny draining of its elephantine balance sheet is designed to help enforce its current 4.83% Fed funds rate. After all, they can’t get rates higher unless they drain away some of the massive floods of liquidity that have been pumped into the financial system during recent years and decades.
Indeed, as much as the perma-bulls would like to think that the Fed has a magic rate-setting wand that it waves at will, the truth is that rates are pegged by metering the supply of funds in the bond and bill pits. It’s the law of supply and demand, driven by people who control the only legal money printing press.
So for crying out loud. What Hyman is doing is double-counting the Fed’s belated effort to reverse the trillions of QE that should never have been printed in the first place. His 7% “effective” Fed funds rate, therefore, is not even an analytical error; its intellectual mendacity of the first order.
Nor is that all. Hyman further averred that inflation is cooling rapidly and that the bond market is telling him that inflation is actually racing back to the Fed’s 2.00% target. The implication is that the effective Fed funds rate is way above the emerging inflation rate.
So real rates are soaring. The inflation battle has already been won. It’s time for the Eccles Building to gets its foot off the neck of the Wall Street gamblers who haven’t made a net dime in 18 months.
Well, it’s no damn wonder that the BFTDers keep coming back to the feeding trough over and over. That is, Wall Street has so corrupted language and analysis that it is literally flying blind. These cats have no idea about where we have been and where we are heading because they are mentally enfeebled by the endless flow of the kind of Fed-enabled sell-side casuistry Hyman was peddling this morning.
Of course, when a putative analyst avers that the bond market is telling him something, we are inclined to ask as to which day he was so enlightened. Is he talking about the 10-year UST yield which was 430 basis points a few months back, 150 basis points a few years back or 340 basis points today?
Stated differently, the unassailable truth is that honest, reliable “price discovery” in the stock and bond markets was destroyed long ago. Indeed, that’s what the Fed’s relentless money-printing has actually accomplished: It has so thoroughly water-logged the financial system with excess liquidity that it has turned these markets into a version of the old football play called “student body left” and “student body right”.
That is to say, one day the herd rushes toward the “sell” key on their bond trading platforms, and the next day toward the “buy” key on their stock trading platforms. On a daily, weekly and even monthly basis, the great flood of liquidity just sloshes back and forth between the bond and stock markets, and among sectors and maturities within them—all signifying not much of anything at all except that the asset-gathers are busying themselves in order to justify their fees.
Nevertheless, today was another CPI release day that initially unleashed a flood of stock buying, but, ironically, it contained no hint whatsoever of Hyman’s reading of the bond market’s entrails.
To be sure, we strongly dispute measuring current inflation by the CPI ex-food, energy and now shelter and whatever else appears to be going up at the moment. Lost purchasing power is lost purchasing power, no matter the mix of price changes that brought it about.
For example, since the year 2000 food prices (brown line) and energy prices (purple line) have gone up well more than the overall CPI (blue line), but the fact is that the consumer’s dollar has lost 44% of its purchasing power in the last 23 years. Accordingly, the mix of items that brought the green line in the chart tumbling down isn’t relevant. Inflation just plain happened.
Purchasing Power Of The Consumer Dollar Since 2000 Versus CPI Component Increase
At the same time, getting a handle on where inflation may be going in the near-term months, or even years, can be accomplished by looking at adjusted indices. In particular, what has been oscillating a lot in the short term is so called “flexible” prices including food and energy.
So when you take those items off the scoreboard, the March CPI reading of the sticky items suggests that there is a pretty solid floor under current rates of headline inflation, and that unless there is a veritable collapse in prices of food, energy and durable goods, inflation is not about to evaporate anytime soon.
In fact, the Y/Y reading for the sticky price index below posted at +6.6% in March, which was the highest gain in 41 years! And it showed no indication of rolling over.
So if the sticky part of the CPI is running at well more than three times the Fed’s target, there is simply no way that the math pencils out to a sharp drop in headline inflation any time soon.
Y/Y Change In Sticky Price CPI Excluding Food And Energy, 1982 to 2023
For want of doubt, we also examined the same index on an annualized three-month rolling basis. In this case, the March figure posted at 5.9%, representing only a modest improvement from the peak rate of 7.1% posted last June.
Actually, the chart below makes clear that the three-months annualized version of the sticky CPI has been zigging and zagging steadily higher since the Lockdowns zapped economic activity in April 2020. Whether the next move is higher or lower, therefore, is mainly beside the point. What is unassailable is that even the sticky and allegedly steady components of the CPI are stuck high and dry in inflation-land.
Annualized 3-Month Change In Sticky Price CPI Less Food And Energy, 2012-2023
It is not surprising, therefore, that the very thing the Fed impacts directly and most immediately—domestic services prices—showed scant evidence of beating a retreat in the March figures. Unless you have a magnifying glass, in fact, it hard to see that the 7.12% Y/Y gain in March was a tenth lower than the 7.27% rate recorded in February.
Either way, high inflation is embedded in the services sector, which comprises upwards of 60% of the weighting in the CPI. No matter how Wall Street perma-bulls torture the numbers, when the Fed looks at where inflation is trending, it is the picture below that comes up on the radar screen—a picture which spells out “no time to pivot”.
Y/Y Change In CPI For Services Less Energy Services, 2012 to 2023
Moreover, when you look at the other side of the equation—the so-called flexible price stuff—there is even more reason to doubt the collapsing inflation story. To wit, food prices are still going up strongly, even as the trend in the durable goods deflator has leveled out and energy prices are fixing to rise once again.
Thus, at the June 2022 inflation peak, the grocery store index (yellow line) was rising at a sizzling 12.2% Y/Y rate. That has cooled slightly since then, but was still increasing at an 8.3% Y/Y rate in March—a level which hardly qualifies as disinflationary.
In the case of durables (black line), the index peaked a year ago at+18.7% on a Y/Y basis and has been cooling sharply ever since. However, this weakening trend was heavily impacted by tumbling used car prices, which are once again on the rise according to the Mannheim used vehicle value index. In March the latter was up +9.7% from in November 2022 low.
In March, therefore, the overall durables index plateaued, meaning that it is likely to start rising again when the now sharply rising Mannheim numbers work their way into the CPI with the usual lag.
Finally, the big reversal in the petroleum-driven energy price index (purple line) is surely over. At the peak last June, these prices were rising at a 41% Y/Y rate but by March had posted at -6.4%., thereby pulling heavily downward on the headline CPI.
Alas, since the CPI was surveyed in mid-March, global oil prices have soared by 20%, rising from $67 to $80 per barrel. And that’s not in the least surprising: The Biden’s administration’s 1.0 million bbls/d SPR release has now ended, and OPEC has just announced an impending cut in collective production by 1.1 million bbls/day.
So, yes, we do believe that more than a 2.0 million bbl/d supply contraction on the global oil market will likely keep prices firmly above current levels
Y/Y Change In Energy, Food And Durables Prices In the CPI, April 2021 to March 2022
In fact, the impending upward shift in energy prices is already evident on the gasoline front. The March headline CPI was flattered by a -4.6% m/m drop in pump prices, but that’s now in the rear-view mirror. Gasoline prices have surged by 7% from the March low and are now at their highest level since early July 2022.
Needless to say, if the sticky components of the CPI are high and, well, sticky, and the flexible components look to be headed north again, its hard to see where the big inflation downshift ballyhooed by the Wall Street perma-bulls will be coming from. And by the limpid price action near the end of the day, it would seem that even they were having second thoughts.
Yet, the flood of liquidity continues to keep the bond market off its game. The 10-year UST yield ended the day at just 3.40%, which is crazy as hell in a world where the CPI is stuck at around 5-6%.
Moreover, the real driver of long-term interest rates just took another turn for the worst. That is, the Federal deficit came in at $1.1 trillion for the first six months of FY 2023, according to a new report by the Congressional Budget Office (CBO). That’s $430 billion more than the shortfall recorded during the same period last year, owing to the fact that outlays grew by 13% while revenues dipped by 3%.
Furthermore, outlays for the three largest entitlement programs rose by $132 billion. This includes a whopping $61 billion/10% increase in spending on Social Security, a $49 billion hike in Medicare outlays, and a $22 billion rise in Medicaid outlays. And yet only the last one is even on the GOP’s so-called spending cut list.
In short, the Fed is still dumping $95 billion per month of existing govenrment debt into the bond pits via QT. That’s per its belated attempt to shrink its balance sheet and drain liquidity from the markets, even as the US Treasury is fixing to pour on a surging level of new supply. That spells higher interest rates and lower PE multiples no matter how you slice it.
Indeed, that much is downright obvious. It’s not surprising, therefore, why even old graybeard perma-bulls are making up nonsense like the “effective” Fed funds rate. They are desperate indeed, and none too soon.
Reprinted with permission from David Stockman’s Contra Corner.
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