Despite what you hear, the inflation trend is lower when you look at the broad rate-of-change over time, writes Landon Whaley.
This week’s “Headline Risk” focuses on the risk of buying into the Old Institution’s obsession with the “levels” of data and the month-over-month change rather than the far more critical annual rate-of-change (ROC).
Let’s begin with an inflationary victory lap. We initially made our “inflation will accelerate from here” call on March 11. Right on cue, both consumer and producer price inflation accelerated in March (we found out in April) for the first time in six months.
We then nailed the pivot to slower inflation in the Playbook on May 27 when we cited the Chicago Fed National Activity Index, the strong U.S. dollar, and import prices all indicating inflation was likely to head south in the months ahead. The inflation data that has followed that proclamation confirms the disinflationary environment, but the Old Institution is once again utterly blind to economic developments occurring right in front of their collective face.
If you’ve been with us for any reasonable stretch of time, you know that one of the ways we can make macro calls and position correctly before markets move is by evaluating economic data in year-over-year terms. To us, it’s highly intuitive to watch the slope (rate of change) of annual data because this provides a clear signal for the data set in question, and it avoids the noise that necessarily plagues the growth rate from one month to the next. Yet what is intuitive to us eludes may market analysts and business media talking heads.
While they follow monthly growth rates that are jumping all over the place like a toddler on a sugar high, the annual growth rate of consumer inflation, core inflation, and producer prices are painting a crystal-clear picture.
Last week, the Old Institution grabbed on to the one-month acceleration in core inflation during June with both hands. While media outlets were touting “core inflation posts biggest gain in nearly 1 ½ years,” the economic reality was precisely the opposite.
In annual terms, core inflation did accelerate in June, but there are two facts overlooked in the exuberance. First, core inflation accelerated to this same +2.1% level back in April, before slowing again in May. One-off bounces in economic data that has been slowing for the better part of a year is not uncommon. Second, despite being back above the 2% threshold, core inflation has now fallen -16% since peaking at an 11-year high back in July 2018.
Turning our attention to consumer inflation, the Consumer Price Index (CPI), following a two-month bounce in March and April, CPI has now slowed in two consecutive months and in eight of the last eleven months. Not only that but this latest reading is the lowest pace of CPI in over two years.
Not only did the experts miss the boat on core and consumer inflation, but sources like Reuters, CNBC, and Fox Business completely whiffed on producer prices as well.
Despite the media’s narrative that “U.S. producer prices rose slightly in June,” the opposite was true, in annual ROC terms.
Producer prices fell for the second consecutive month and for the sixth time in the last eleven months. More importantly, producer prices have halved since peaking at a seven-year high last July.
And if that’s not enough slowing inflation data for you, June’s import price growth slowed for the ninth month in the last 12 and contracted for the sixth time in the previous seven months.
The media didn’t discuss the accurate signals being sent by the data because they’re too busy looking at the levels of the data and monthly growth rates.
Remember, their “levels” obsession means they fail to spot shifts in Fundamental Gravities until months after the fact. By the time the data has deteriorated (or accelerated) to “levels” that send them a clear signal, asset classes have already responded to the new economic conditions. In short, by the time the Old Institution acknowledges the changed environment, the low-risk, high-reward trades are as dead as disco.
The headline risk bottom line is that the most critical inflation gauges are confirming that the slowing inflation regime that began last summer is gaining downside momentum once again. Couple this reality with the myriad of growth slowing data, and there is no doubt that Winter is here. Trade accordingly.
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