Mostly Peaceful Inflation

By Michael Every of Rabobank

The best way to summarize the sharply different interpretations of yesterday’s US CPI number was “mostly peaceful.” For Mr. Market, headline inflation jumping 0.6% m-o-m, 7.2% annualized, was not important. Neither was the y-o-y rate rising from 3.2% to 3.7%, a tick above the 3.6% expected. Instead, the focus was on core CPI, up 0.3% m-o-m, so 3.6% annualised, and 4.3% y-o-y, down from 4.7% – that latter drop was all that mattered. After all, the headline rise was “driven by energy.” Well, yes, but energy goes into *everything*, as our strategist Joe DeLaura keeps repeating, alongside structural risks to the upside. Brent is now at over $92, up nearly 10% m-o-m, with unhelpful y-o-y base effects for the next six months to boot.

Even a 3.7% y-o-y average price hike is on top of 8.2% in August 2022 and 5.2% in August 2021, meaning a total rise of 18.1% since August 2020. Yet some tell us to eat cheap cake.

Professor of Economics @JustinWolfers explained average US grocery prices have been unchanged for six months: someone replied on X that his income of over $300,000 insulates him from such real-life observations. Nobel Prize-winner Krugman told CNN, “The economic data have been just surreally good. Even optimists are just stunned.”  “So why do polls show most Americans don’t think the economy is doing well?”, asked Christiane Amanpour. “There’s a really profound and peculiar disconnect going on,” was his reply.  He also tweeted, “So basically the data are now saying that the war on inflation has been pretty much won – without a recession.” Perhaps he was looking at the numbers on his fax machine, not his iPhone.

I can fiddle with data as well as the next analyst, but outside cloistered circles people are *deeply* unhappy with the state of the economy because of inflation. Those with a better feel for things than rate-cut addicted markets and bubble boys can pick up on that vibe.

Even The Rolling Stones latest hit is called ‘Angry’. The band who sang of Street Fighting Men in the 60s, and by the 90s were so rich it was joked they all lived in a Manhattan penthouse, feeding on cocaine and diamonds with prehensile tongues, capture the 2023 zeitgeist with a new album called ‘Hackney Diamonds’. That’s London slang for the broken glass left behind after car windscreens have been smashed. The title is supremely appropriate in that most of Hackney –still a byword for urban poverty– is now unaffordable to either buy or rent in. A generation are in Exile on Main Street; can’t afford groceries on Main Street; or find there’s no Main Street anymore.

Wait and see what happens if energy stays high, spreads into goods and services, and central banks look through it to ‘focus on core’ CPI: a Stones-y 70’s vibe, or maybe a 1968 one.

Think what happens if central banks have to act again. You can see why Mr. Market mostly prefers not to think – with a few exceptions. For example: ‘Forget steady US CPI, this $256bn bond guru says soft landing is a ‘fairy tale’. Arif Husain says bond yields are going higher just as the economy starts to crack, and “there’s very little to catch us on the way down.”

Meanwhile, central bankers’ jobs are being complicated by geopolitics, something we’ve been flagging for years: everyone loves free trade as an exporter; only the Anglosphere loves free trade as an importer, and that’s finally changing too. Indeed, as China flags security risks with iPhones, the EU just announced an investigation into subsidies for Chinese EVs.

In essence, as China points out the EU is also using subsidies for its nascent EV production, Europe’s complaint is that China has out-industrial-policied it. Yet either the EU loses the vital auto sector, or it adopts China-style policy. The former means deindustrialisation. The latter means tariffs, higher EV prices, and stronger unions making higher wage claims, as in the US auto sector – and some German unions are already pushing for a four-day week. Either way, Germany takes a hit. If the EU doesn’t act, German automakers suffer in Germany. If it does act, German automakers suffer in China.

If you think this is all just a Western problem, think again. Bloomberg revealed yesterday that ‘Bankers’ 40% Pay Cuts Show the China Dream Fading in Its Richest Cities’, with numerous examples of private-sector salaries being slashed by up to 50%, and many workers responding by ‘lying flat’. There were also some suggestions that public sector salaries in the struggling northeast have been cut 20%. (Tell me again about an imminent ‘rebalancing to consumption’.) Of course, that Chinese action is deflationary. But the EU action on EVs underlines it isn’t going to absorb excess, cheap Chinese production anymore, just as the US has seen Mexico become a larger source of imports than China.

Aussie jobs data today were strong enough (+64.9K vs. 25K expected) that Ben Picton thinks they back another RBA rate hike to 4.35% later this year. However, one does also need to factor in that the Aussie population will expand by around 600,000 people in 2023 via new arrivals, many of whom work. Yet even if that means supply and demand for labour is better balanced than it might appear, it isn’t for homes to buy or rent. That will continue to push up wages and inflation – or people will sleep in the streets. Note that rate hikes will make matters worse, as landlords pass on the mortgage costs to renters, and developers build fewer homes. Also note that rate cuts will make matters worse, as landlords don’t pass on the savings to renters, and speculators and new buyers push up housing prices even further, forcing many to rent. And as in Australia, so elsewhere. “Don’t get angry at me,” as Jagger snarls. But get angry at somebody.

Against that backdrop, the ECB is up today. Our Eurozone team still narrowly favour a ‘Hawkish Hold’ at what they see as “quite possibly… the hardest juncture in its hiking cycle.” They expect the ECB to maintain that more hikes may still follow ahead. On one hand, the growth outlook is deteriorating, with official downward revisions seen for both the Eurozone and Germany yesterday, and overtightening is becoming a real possibility. Yet at the same time, inflation remains high, with suggestions it will be projected at over 3% in 2024, and thus the odds of another hike are more than just a tail risk. The team sees a small risk of an increase in the minimum required reserves at this meeting, which would also have a market impact.

To summarise:

• Growth is too low, with risks to the downside;
• Inflation is too high, with risks to the upside;
• Official forecasts say we will be half-way through this decade before things go back to ‘normal’;
• Geopolitics says that is unlikely to happen at all; and
• The population who don’t read or watch Bloomberg are already *furious*.

In short, the outlook is anything but ‘mostly peaceful’. Or exactly that in the ironic meme sense. Worry about the Stones; and bricks; and baseball bats; and pickaxes, etc.