This morning brought the release of the latest PCE deflator, and it wasn’t good. The year over year rise in prices was 4.4% in April, a 0.2% increase over March’s 4.2%. The so-called “core” rate was even less encouraging, at 4.7%.
Financology readers aren’t surprised. We’ve been watching asset prices rise and the dollar weaken for months, noting it was only a matter of time before that inflation made its way through to final goods and services. Markets responded by raising interest rates across the 1-5 year spectrum, as well as anticipating the Fed may follow, throwing cold water on hot speculation the Fed signaled a “pause” this month.
The one month Treasury yield broke above 6% today, the first of any of Treasury’s regularly published yields to do so since April 1, 2002. This milestone was mostly unremarked upon by a financial media giddy over AI, but is shocking given that we saw the first five handle in years in only February.
Daily Treasury Par Yield Curve Rates
We’ve watched inflation work its way through the pricing chain before, for instance in February 2021:
Over the following months, measures in final inflation (consumer prices and wages), began to follow suit. After a period of denial, the Fed finally began to tighten monetary policy.
For most of 2022 the dollar was strong, as reflected both in the forex markets where it rose against foreign currencies, and in the stock and bond markets where it rose against, well, stocks and bonds. It even rose against many commodities as well, even gold. Or looked at the other way, they declined in dollar terms. With a lag, this was reflected in final inflation figures declining from their peak through the second half of the year.
But this virtuous cycle peaked early in the fourth quarter. Asset prices began to rise again as the dollar likewise weakened in the forex markets and lost ground to gold. Final price inflation continued to decline, but at a declining rate, finally reversing higher in April, as the depreciating dollar worked its way through the pricing chain and into consumer prices.
So now what? Speculation is now rising the Fed may have as many as two more rate hikes in store. I’ve suggested in these pages that the Fed may be putting too much of the burden on the Fed funds target, and not enough on the balance sheet, particularly the MBS rolloff (in light of the already supply-burdened Treasury market). For its part, however, the Fed may be more patient than much of its more hawkish rhetoric might suggest. As far as we know, it intends to continue trimming the balance sheet even if it pauses on rate hikes. This might be behind some of its commentary about it taking a long time to bring inflation to heel …they know at this pace of balance sheet runoff it will take a while to overcome the effects of the massive increases of 2008-2021.
If so, then we may have to be patient as well. But the mainstream narrative … that stock prices can continue to rise without limit while consumer price inflation comes in for a soft landing … well … I just don’t see it.
the fed’s decision to buy mbs, from the beginning and especially even after house prices were rocketing higher, invites scrutiny. the best explanation i’ve come across is that the fed was bailing out some large player that had to unload a lot of mbs for some reason. the fed hasn’t been in a hurry to dump those mbs, either. i wonder what closets those skeletons are in.
it looks like the economy remains quite strong, and while truflation.com is showing current inflation at 2.88%, that’s not the number the fed is looking at. i said half facetiously, a while back, that the fed might go to 6%. i’m beginning to wonder if i was right.
as for the 6% you point to, isn’t that – for now – just an aberration because of the hijinks around the debt ceiling? the 1 mo rate is 6.02 while the 2 mo rate is quite a bit lower, at “just” 5.47, with rates going down from there as you extend maturities.
Yes you did mention a potential 6% Fed funds … seeing this 6% reminded me. And it’s looking less out there by the day. Sure some of that is probably debt ceiling related; the short end has been notoriously noisy. Otoh it’s also not a committee decision; it’s a real market rate. Then there’s that rise into four months …? But I’m not trying to draw inferences so much as just look at it in awe. It is what it is.
If someone had told me I’d see a six handle on any of these yields a year ago I’d have been amazed … even if it was in February when we saw the first five it would have prompted lots of questions.
And yes that orgy of MBS buying even after housing prices were on a tear was bizarre … I was one of the scrutinizers. I don’t know why … it certainly seems possible there was more to it, but the whole policy zeitgeist was bizarre … they just seemed determined to nuke everything in sight.
I’m not familiar with Truflation’s methodology. There’s more than one valid way to calculate inflation, as discussed in detail in the linked 2021 FDI post. My preference is usually to look at the leading edge in real time markets but in this case the message from the trailing edge is similar … whatever the rate, it appears to be rising again. This can change at any time though. At least the Fed seems to be leaning in the direction of data dependence and away from dogmatically following a preset course.
at what point do you think that the stimulative effect of treasury paper PAYMENTS, which put more cash into the economy albeit mostly to the well-off as well as pension funds and endowments and so on, outweigh the restrictive effect of interest rate hikes?
If I understand the question right, I would focus on net borrowing/repayment … that is, just the amount by which repayment exceeds borrowing. That’s a solidly negative number for the foreseeable future, but changes in the rate shouldn’t take long at all to start showing up in at least some data.
On this point, have you seen the GMO piece linking government deficits with corporate profits? I cited it in The Economics of Equity. Hussman has referred to this as well. The implication is that a decline in deficits would be accompanied by a decline in corporate profits.
I don’t see debt repayment as stimulative per se though. It actually decreases the money supply. Money is lent into existence … when it is repaid it goes back where it came from. This is why the Fed’s balance sheet expands when it buys Treasuries and contracts when it sells them. The dollars it uses to buy them with are created in the act of buying. Conversely the dollars it receives for the sales vanish into the aether. The dollars received by other buyers don’t contribute; they merely change hands.
This is also why net borrowing appears to be “stimulative”; it increases the money supply. Inflation looks like “expansion” at first. Deflation looks like “recession”.
ps i forgot to add the stimulative effect of deficit spending per se. even if the money is borrowed from private domestic sources, if is a flow from those with a low propensity to spend to entities which are in fact spending.
Very much so. Higher interest rates “work” by making borrowing more expensive and in turn disincentivizing it. But in this cycle until now government has been a price insensitive borrower. Probably a few private institutions as well, as some borrowing is planned in advance. The reaction to pricier borrowing is less than instantaneous. This would account for part of the lag between monetary policy and economic response. As mentioned in the prior comment, government deficits turn into corporate profits … they’re a transfer from the public sector to the corporate sector.