The Signal and the Noise

Global CIO Commentary by Scott Minerd

U.S. Federal Reserve Chairwoman Janet Yellen’s press conference last week came just hours after Consumer Price Index data revealed inflation of 2.1 percent year over year. Nevertheless, she was exceptionally dovish and sanguine on inflation. Yellen contended that even though the U.S. economy is near the Fed’s objectives of full employment and price stability, recent data on inflation was “noise” and there continues to be considerable underutilization in the labor market. This was only the most recent demonstration of a willingness among Fed policymakers to highlight any number of economic data points to support accommodative monetary policy. It came even though labor conditions are improving toward a level associated with the non-accelerating inflation rate of unemployment (NAIRU); a tipping point of around 5.5 percent unemployment which has historically corresponded with a period of Fed tightening.

I am increasingly of the view that the Fed and investors are complacent about inflation. While a broad-based secular increase in inflation is most likely a problem for the next decade, there are a number of technical and cyclical forces working to push consumer prices higher. One technical factor is the one-time 2 percent Medicare payment cut which went into effect in 2013 and temporarily depressed healthcare costs for Medicare recipients. The recent increase in healthcare costs results largely from the year-over-year effects of this one-time cost reduction expiring.

Another inflation factor at work is shelter. With rental vacancy rates hovering near 13-year lows and new home sales soaring by 18.6 percent to an annualized pace of 504,000 units in May, we can expect a continued rise in shelter costs for the rest of the year and possibly into early 2015. As a result of these technical issues and the cyclical factors associated with the economic expansion and employment growth gathering pace, we are likely to see inflationary pressures continuing to build. It is clear that we have now passed the days of low inflation growth.

We are in the late stages of a bull market and, as I have noted before, bull markets do not die of old age, but typically end as a result of a policy misstep. If Fed policymakers want to avoid such a mistake, they might start listening more closely to the “noise.”

U.S. Shelter Inflation Likely Heading Higher

May’s Consumer Price Index (CPI) data surprised to the upside, with transportation and medical costs adding to the 0.3 percent month-over-month gain in core CPI. However, the biggest contributor to increasing consumer prices continues to be shelter costs, which account for over 40 percent of core CPI (and 22 percent of core Personal Consumer Expenditures (PCE), the Federal Reserve’s favored gauge of inflation). Shelter inflation measured by CPI is already up 2.9 percent from a year ago, and due to falling vacancy rates and gains in home prices, shelter costs could accelerate to nearly 4 percent growth over the next year, which would push core CPI well above 2 percent.

ACTUAL CPI SHELTER YEAR-OVER-YEAR PERCENT CHANGE VS. MODEL SUGGESTED SHELTER INFLATION

Source: Haver, Guggenheim Investments. Data as of 06/25/2014. Note: Model inputs include the rental vacancy rate (six-quarter lead), home prices (seven-quarter lead), and growth in working age population (24-quarter lead).

Economic Data Releases

U.S. Home Sales Accelerate

• Existing U.S. home sales for May beat expectations, rising 4.9 percent to an annualized rate of 4.89 million. Gains were concentrated in single-family homes.
• New home sales were very strong in May, surging 18.6 percent to an annualized pace of 504,000 units.
• The S&P/Case-Shiller 20-City Home Price Index showed a sharp drop in home-price appreciation in April, with the year-over-year reading falling to 10.82 percent versus 12.37 percent in March.
• The FHFA House Price Index in April was worse than expected, showing no growth in prices.
• The Leading Economic Index increased for a fourth straight month in May, rising 0.5 percent. An improving labor market and low interest rates contributed most of the gain.

• Durable goods orders unexpectedly fell in May by 1.0 percent, but the weakness was concentrated in defense spending. Non-defense capital goods order, excluding aircraft, rebounded by 0.7 percent after declining in April.
• The Philadelphia Fed Business Outlook Survey reached the highest level since last September in the June reading, climbing to 17.8.
• The Conference Board’s Consumer Confidence Index jumped to a new high in June, reaching 85.2, the best since early 2008.
• Initial jobless claims fell by 6,000 to 312,000 for the week ended June 14.
• First-quarter GDP was revised down sharply to -2.9 percent, primarily due to revisions in consumption.

European PMIs Slow, China Manufacturing Expands

• The euro zone manufacturing PMI showed a slower pace of expansion in June at 51.9, down for a second consecutive month. The services PMI was also weaker at 52.8, decreasing from 53.2.
• Germany’s manufacturing PMI inched up to 52.4 in June from 52.3.
• The German IFO Business Climate Index fell for a second consecutive month in June, down to 109.7, a six-month low.
• Germany’s GfK Consumer Confidence Index rose to 8.9 in July, the highest level since 2006.
• France’s manufacturing PMI in June was below expectations at 47.8, the lowest level since December.
• The HSBC China Manufacturing PMI in June was better than expected at 50.8, rising into expansionary territory for the first time this year.

VIDEOS AND PODCASTS

 

2022’s Upside: The Fed Has Put the Income Back in Fixed Income

Anne Walsh, Chief Investment Officer for Fixed Income at Guggenheim Investments, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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2022’s Upside: The Fed Has Put the Income Back in Fixed Income

 

Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Fixed Income, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.

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Macro Markets Podcast: Episode #26