Yesterday a far more talented sell sider than myself @barnejek in a discussion on the relentless rise in US real rates over the past two months sparked this post at BI and it lead to continued discussion on twitter and a few more posts about the recent fall in inflation rates. I took a few issues with it and received many questions so it’s far too much for twitter.
First and foremost the tweet makes no sense because inflation in the US has been stubbornly low for the past two decades, so unless you think it’s going lower from these current depressed, generationally low, levels saying goodbye to inflation is ridiculous. If however, that is your actual opinion please reach out in the comment section I would be thrilled to enter a swap to that effect.
Here are US benchmark real rates and their ramp up since April. I’ve been saying for the past seven months that short 5y TIPS was the best trade on the planet as they had all the overvalued characteristics of USTs but with positive carry. I still like the trade but the recent run up in the inflation expectation component of it looks overdone. As such I find it hard to see inflation going any lower from here.
Here’s the benchmark breakevens where the move has been just as staggering, the two year most notably is off 114bps.
US inflation levels are quite low. PPI leveled off last month but CPI and PCE both surprised to the downside. Luckily, this trend looks to have reversed last month.
Inflation will be supported by the recent climb in wages which were the input most severely impacted by the payroll tax increase. If I had to peg the soft inflation from the spring to one thing, that would be it.
It is important to look at wages coupled with consumer credit which was also continued to expand.
The most stable of the bunch core PCE has a good long term track record with the 5y UST, where the recent rise in yield points to upward pressure.
Last month’s CPI reading looked like a fluke to anyone who follows it.
The reading was inconsistent with the data from PriceStats (formerly the billion prices project) where prices have been rising for weeks.
Case-Shiler showing CPI should face continued pressure from rising home prices and rent equivalents.
Lastly to show just how overdone the move in short term inflation expectations has become here’s crude oil charted against the 2y breakeven. Since it factors so heavily into both consumer and producer inflation it has had a great predictive factor.
That said, my base case if for inflation rates moving significantly closer to the Fed target of 2% over the next 6-9 months.
