June 16, 2024

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Good, not great, news on inflation

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Good morning. Stocks hit an all-time high yesterday, passing the peaks of March. As a financial journalist, this makes me nervous. As an investor, it makes me happy. Tell me which me is right: [email protected]

CPI inflation: good enough for now

Every month Unhedged publishes a chart more or less like the one below. For the first time in 2024, we can do so without cringing:

Line chart of Core CPI inflation, month-over-month change, annualised showing A little relief

Line go down! Good! After three months in which the month-over-month change in core inflation was 0.4 per cent, or an annualised rate well over 4 per cent, April’s figure was 0.3 per cent, or 3.6 per cent annualised. A meaningful improvement.

Why, then, did the market not seem to care more? Yes, two-year Treasury yields fell a respectable if hardly giddy 9 basis points; equities rose by more than a per cent. But what did not change much was the market’s expectations for interest rate cuts. Yesterday, the futures market expected 43bp of cuts by December. Today? 52bp. Meh.

What the market is demonstrating is the difference between relief and surprise. There were good reasons to expect that April’s numbers would be quite a bit better than the three preceding months, and they were. But there were good reasons to be hopeful about February and March, too, and those hopes were dashed. So yields and equities are showing relief. But the basic picture has changed relatively little. There were no big positive surprises that would upend the market’s forecasts for interest rates. Don Rissmiller at Strategas sums up with characteristic even-headedness: “The Fed has remained on hold, and today’s inflation reinforces that decision.” 

What the Fed most wants to see is for services prices to stop climbing. But the better part of the April improvements came in goods. In particular, the drop in car prices, both new and used, gathered pace, a trend that is expected to continue.

But there was also some goodish news on the services side. Airfares continue to fall. Car insurance is still rising fast, but not as fast. And what really matters is the biggest and most closely watched service category of all: shelter. Rent fell nicely and owners’ equivalent rent edged down: 

Line chart of CPI shelter inflation components, month-over-month % change, annualised showing Anywhere I lay my head

The moves may not look impressive. And indeed compared to private rent measures that focus on new leases, the CPI numbers still look woefully sticky. But Omair Sharif of Inflation Insights sees reasons for hope in the details. When the seasonal adjustments in the index are removed, the trend looks more encouraging. And he points out that the Cleveland Fed’s indices of new tenant rents (NTRR in the chart below) and all tenant rents (ATRR) tend to lead CPI rent by four and one quarters, respectively, and they are pointing towards further declines in rent in the months to come. 

Reason for optimism, then. But it is important to keep it simple. Look back at the first chart, above. April was an improvement, but it’s just one month, and we are still above the Fed’s 2 per cent target. The multi-month averages are still well above target. There is a way to go, and the path will not be smooth.

Gold and central banks

Yesterday I wrote about the rally in gold, which I still think is hard to justify on fundamental grounds. Many readers wrote to point out that I had under-weighted the shift in central bank gold buying as a factor. They have a point. Here, from James Steel of HSBC, is a long-term chart of global central bank gold purchases:

The banks have been buying about 400 tonnes a year since 2010 or so, but in 2021 and 2022 they bought twice as much, and last year they were still at about 750 tonnes. What has changed? Joseph Wang, the central banking maven formerly known as Fed Guy, has thoughts. While the dollar remains the dominant currency in both global trade and global currency reserves, “China block” countries have increased their holdings of gold from very low levels to about 7 per cent of total reserves. He borrows this chart from the IMF: 

China’s own gold allocation is still very low compared to other countries, and its “buying spree” suggests it may be intent on changing that. Whereas in the years after 2008 China diversified its reserve holdings by converting them to loans to countries where it hoped to draw into its sphere of influence, it may be shifting to gold, a process which could play out over many years.

Steel explains the appeal of gold to central banks as “a little more subtle than a simple de-dollarisation story”. The dollar remains the dominant reserve store, but a shift of central banks’ portfolios towards gold reflects a desire to diversify somewhat. The currency alternatives to the dollar (euro, pound, yen) are not particularly appealing; gold allows banks to diversify without buying them. And gold reserves can be mobilised to pay debts, address current account imbalances, or head off a currency crisis.

I am sceptical of end-of-the-global-order-as-we-know-it stories as justifications for any investment strategy. These things are too hard to predict. But if central banks are steadily shifting their allocations towards gold, that is more than just a story. There is only one problem. The violent jump in the gold price this year, which broke through the symbolically important $2,000 level, happened well after the big increase in central bank buying in 2022. Those who buy gold now might be following the central banks. But they are also participating in a speculative frenzy. 

One good read

Good dogs.

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