How long can the Fed whistle past the "There is no inflation" graveyard before raising rates?

David Goldsmith

All Powerful Moderator
Staff member

Inflation Galore at Manufactures, amid Massive Shifts in Demand, Supply-Chain Snags, Shortages, Lack of Shipping Capacity. And They’re Passing it On​

For now, the story is that the sudden and massive shifts in the economy in 2020 have caused shortages and distortions in the goods-producing sectors and in shipping and trucking, as consumer spending has shifted from services – such as flying somewhere for vacation and spending oodles of money on lodging and restaurants and theme parks – to goods, particularly durable goods.

The story is that prices are rising because components and commodities are in short supply, and supply chains are dogged by production issues, and are facing transportation constraints, as demand for those goods has suddenly surged. And that all this is temporary.
And the Fed has said it will ignore inflation for a while, that it will allow it to overshoot, and only when it overshoots persistently for some unknown amount of time and becomes “unwelcome” inflation – “unwelcome” for the Fed – that it will try to tamp down on it.
Meanwhile, inflation pressures are building up. Two reports out today show a large-scale surge in price pressures for manufacturers – and they’re able to pass them on to their customers.

The Prices Index “surged dramatically in January” to a level of 82.1%, after an eight-month upward trajectory, the highest since April 2011, “indicating continued supplier pricing power,” said the Manufacturing ISM Report On Business.
In the ISM data, a value above 50 means expansion, and a value below 50 means contraction. The higher the value is above 50, the faster the expansion. January saw the fastest expansion of the Prices Index since April 2011 (data via YCharts):

Of the roughly four dozen commodities in the index – from corrugated boxes via cold rolled steel and plastic resins to memory chips – only one showed a price decline (caustic soda); all others increased. Some of the prices started increasing more recently, but others have been increasing for eight months, including copper.
A number of commodities were considered in “short supply,” including:
  • Copper
  • Corrugated Boxes (for 3 months)
  • Electrical Components (for 4 months)
  • Electronic Components (for 2 months)
  • Freight, trucking
  • Semiconductors (for 2 months);
  • Steel (for 2 months), cold rolled; fabricated; and hot rolled.
The ISM data is based on how executives see business conditions at their own companies. The names of the companies are not disclosed in the report. Executives are asked if various business conditions – orders, prices, employment, etc. – are up or down in the current compared to the prior month.
Concerning prices, 64.3% of the executives said that prices rose in January compared to December, while 35.7% said that prices remained the same, and 0% said that prices declined.
For manufacturers and their supply chains, the shifts in the economy, and also other issues are contributing to a slew of problems: “Survey committee members reported that their companies and suppliers continue to operate in reconfigured factories, but absenteeism, short-term shutdowns to sanitize facilities, and difficulties in returning and hiring workers are continuing to cause strains that limit manufacturing growth potential.”
Similar price pressures were reported today in the IHS Markit U.S. Manufacturing PMI, which added that manufacturers, given the strong demand, were able to pass a portion of these cost onto their customers via increases in selling prices.
In January and also December, supplier performance “deteriorated to the greatest extent since data collection began in May 2007,” the report said. “Supply chain disruption reportedly stemmed from raw material and transportation shortages, notably trucking,” and also from overseas “due to a lack of shipping capacity.”
“Lead times are lengthening to an extent not previously seen in the survey’s history, meaning costs are rising as firms struggle to source sufficient quantities of inputs to meet production needs,” the report said.
And “amid favorable demand conditions,” manufacturers were able to pass these higher costs on to their customers via higher prices, “with selling prices rising at the fastest pace since July 2008.”
The report cited strong demand for goods from consumers and from businesses that “are investing in more equipment and restocking warehouses.”
The report too assumes that the supply conditions will start to improve, and “these price pressures should ease,” but they “could result in some near-term uplift to consumer goods price inflation.”
So for now, everyone is on the bandwagon that these price pressures are just temporary, a result of the sudden shifts in the economy, and that they will reverse when those shifts reverse.
Consumer spending on goods has surged in 2020, particularly on durable goods, as demand for services, which account for nearly 70% of the economy, has dropped sharply. There is now massive inflation in shipping costs, including ocean freight, driven by the surge in demand for goods and capacity constraints. In December, spending on durable goods, though down for the second month in a row, was still up 11% from a year earlier after a historic spike in demand (from Americans Cut Back as Income from Wages & Salaries Hit Record as 10 Million People Still out of Work: Weirdest Economy Ever):


David Goldsmith

All Powerful Moderator
Staff member

Inflation Pressures Heat Up Even in Services​

Big parts of the services sector – such as restaurants, entertainment, lodging, and travel – have been hit hard during this crisis. Other parts of the services industries – such as real estate, services related to ecommerce, transportation services, video games, streaming services, etc. – have boomed. And other segments in services have muddled through. Services account for nearly 70% of the economy. Despite the decline in overall demand for services, inflation pressures are heating up – both in terms of prices paid by service firms, and the prices they charge their customers, according to two measures for these price pressures in January.
Across the US service sector, “cost burdens soared once again, with the rate of input price inflation the fastest since the survey began in 2009, according to the IHS Markit U.S. Services PMI this morning. “And the rate of increase has now accelerated for three successive months,” it said.
“Firms largely passed on higher costs to clients through a marked rise in charges,” it said, meaning that the resistance to higher prices appears to have faded, and companies get away with raising prices without losing customers.
“Service providers recorded a steep increase in selling prices during January,” it said amid “strong client demand and a spike in input prices.”

“The rate of charge inflation was the second-quickest on record [its records going back to 2009], only slower than the peak seen in November 2020,” it said.
“Inflation therefore looks likely to be pushed higher in the near-term,” it said.

And yet, business for the services sector is not red hot.

Hiring has been slow: “Despite a faster rise in new business, a number of firms reported sufficient capacity to process incoming new work in January. As a result, companies increased workforce numbers only marginally, and at the slowest pace since July 2020.”
“The increase in outstanding business was the softest in the current seven-month sequence of expansion,” it said.
And there is still the theme that some of this inflation is just temporary, a result of the distortions during the Pandemic.
“Some of these price pressures reflect short-term supply constraints, which should ease in coming months as the recovery builds and more capacity comes online,” it said.
Also this morning, the Institute of Supply Management released its Services ISM Report On Business. It also reported surging input prices, though the pace of increase in January has slowed somewhat from the November surge, which had been the fastest in years.
The ISM’s index for prices at 64.2 was down 0.2 percentage points from December (seasonally adjusted), indicating that prices increased but at a slightly slower rate than in December.
A value above 50 indicates expansion. A value below 50 indicates contraction. The higher the value is above 50, the faster the expansion (data via YCharts):

Both PMIs here – the one from IHS Markit and the one from ISM – base their data on how executives see business conditions at their own companies. The names of the companies are not disclosed in the reports. Executives are asked if various business conditions – orders, prices, employment, etc. – are up or down in the current month compared to the prior month.
Of the 18 service industries in the ISM index, 16 reported price increases in January, compared to December, and two industries reported no change. The 16 industries that reported an increase in prices paid were in that order:
  1. Wholesale Trade
  2. Construction
  3. Agriculture, Forestry, Fishing & Hunting
  4. Retail Trade
  5. Accommodation & Food Services
  6. Mining
  7. Arts, Entertainment & Recreation
  8. Transportation & Warehousing
  9. Health Care & Social Assistance
  10. Professional, Scientific & Technical Services
  11. Public Administration
  12. Utilities
  13. Management of Companies & Support Services
  14. Other Services
  15. Finance & Insurance
  16. Educational Services.
A step or two further down the road, at the consumer level: The Consumer Price Index picks up price changes well after companies are reporting them.
The CPI for services (red line in the chart below) has increased mostly between 2% and 3% year-over-year for the last decade and has dropped during the Pandemic, as demand for many services (hotels, flights, etc.) has collapsed.
Prices of nondurable goods (green line), which include food and energy, have gyrated wildly over the years, in response to volatile commodity prices.
And the CPI for durable goods (black line), whose year-over-year increases are almost always lower than services, and have been negative thanks in part due to rampant “hedonic quality adjustments,” has begun to spike amid a historic surge in demand:

During the pandemic, the collapse of some services, including travel, has caused those prices to drop, but people’s budgets aren’t going to those services at the moment. The budgets have been redirected to purchases of goods – particularly durable goods whose prices have jumped.
The manufacturing PMIs two days ago revealed the sharpest price increases in years, input prices and selling prices, as the goods producing sector has experienced a sudden surge in demand amid shortages of components and commodities – including semiconductors – due to the sudden shifts in the economy.
What the services PMIs are telling us is that there are price pressures now building up even in services though the services sector overall is far from having recovered, and in many aspects of services, demand remains weak.

David Goldsmith

All Powerful Moderator
Staff member
I wish they had included a chart for iPhones.

Dollar’s Purchasing Power Drops to Record Low, Despite Aggressive “Hedonic Quality Adjustments”​

Spiking prices for new and used vehicles under the microscope.

The “Purchasing Power of the Consumer Dollar” – part of the Bureau of Labor Statistics’ Consumer Price Index data released today – is the politically incorrect mirror image of inflation in consumer prices, as measured by the Consumer Price Index (CPI). By wanting to increase consumer price inflation, the Fed in effect wants to decrease the purchasing power of the consumer dollar, to where consumers have to pay more for the same thing. Thereby it wants to decrease the purchasing power of labor paid in those dollars.
And that purchasing power of the dollar in January dropped by 1.5% year-over-year to another record low:

Note how the purchasing power of the dollar recovered for a few months during the Financial Crisis, when consumers could actually buy a little more with the fruits of their labor. The Fed considered this condition a horror show.
Inflation in durable goods, non-durable goods, and services.
The overall CPI for urban consumers, the politically correct way of expressing the decline in the purchasing power of the dollar, rose 1.4% in January, compared to a year earlier.
Each product that is in the basket of consumer goods tracked by the CPI has its own specific CPI. And all these products fall into three categories: durable goods (black line), nondurable goods (green line), and services (red line), with services accounting for 60% of the overall CPI. Here they are, with discussions below:

The CPI for services (red line) – everything from rent to airfares – increased mostly between 2% and 3% year-over-year for the last decade, but dropped during the Pandemic as demand for services such as hotels, flights, and cruises collapsed. For example, in January, year-over-year, the CPI for:
  • Airline tickets: -21.3%
  • Hotels: -13.3%
  • Admission to sporting events: -21.4%.
The CPI for nondurable goods (green line) is driven by the volatile categories of food and energy. Energy prices, such as gasoline, plunged in earlier in 2020 as demand collapsed, but started to rise months ago. Food prices too are rising. In January, the CPI for nondurable goods was up 0.7% from a year ago, after having been down 3.6% year-over-year in May.
The CPI for durable goods (black line) has spiked in recent months on a year-over-year basis amid a surge in demand for some durable goods. In January, it was up by 3.5% from a year ago The past three months have been the steepest year-over-year increases since 1995.
The ironic element here is that CPI for durable goods declined for much of the past 20 years though new cars and used cars and smartphones and a million other things have gotten more expensive. The decline was in part due to aggressive “hedonic quality adjustments” – we’ll get to those in a moment – which remove the costs of quality improvements from the CPI.

New and used vehicles and “hedonic quality adjustments.”

New and used vehicles account for 16% of the CPI for durable goods.
Prices of new vehicles have soared over the years. The industry measure of “average transaction price” indicates how much money consumers spent on average per new vehicle, a function of price increases and a greater percentage of high-dollar vehicles in the mix. In January, per J.D. Power, the average transaction price soared by 11% from a year ago (to $37,165).
But the CPI for new vehicles in January ticked up by just 1.3% from a year ago.
To demonstrate how silly the CPI for new vehicles is compared to what consumers actually pay for new vehicles, I constructed the WOLF STREET “Pickup Truck & Car Price Index,” which takes the Manufacturer’s Suggested Retail Price (MSRP) by model year of the best-selling truck and of the best-selling car over the decades and compares them to the CPI for new vehicles. The discounts and incentives are there every year and so cancel out when comparing year-over-year price increases.
Since 1990, the CPI for new vehicles has risen by 22.5% (green line). Over the same period, the base MSRP of the Toyota Camry LE has soared 68% (red line); and the base MSRP of the Ford F-150 XLT has skyrocketed 170% (blue line):

In dollars terms, since 1990: The Camry LE base MSRP rose from $14,658 to $24,970; the F-150 XLT base MSRP rose from $12,986 to $35,050; and the CPI for new vehicles rose from an index value of 121.9 to a value of 149.4, and stunningly is today just a tad above where it had been 23 year ago in January 1997:

A big part of the difference between actual price increases and the CPI for new vehicles are the “hedonic quality adjustments” that started to be applied with increasing aggressiveness in the late 1990s through today. The logic is that vehicles have gotten a lot more sophisticated over those years, for example, going from three-speed automatic transmissions to 10-speed computer-controlled transmissions. The hedonic quality adjustments remove the costs of these quality improvements from the CPI.
Even if this is calculated properly, without a political agenda to distort CPI downward, it puts the consumer in a bind because at the lower 60% of the income scale, wages have barely kept up with the overall CPI, but have not nearly kept up with the price increases deemed to be due to quality improvements.
Consumers have responded to these price increases by buying fewer new vehicles, switching from new to used vehicles, driving vehicles for longer, from 8.9 years on average in 2000 to 11.9 years in 2020, and financing them for longer, with seven-year auto loans now being all the rage.
The CPI for used vehicles is also subject to these hedonic quality adjustments. So the same scenario is playing out here. But, but, but… among the distortions of the Pandemic was a sudden and historic spike in used vehicle prices over the summer that couldn’t be removed with hedonic quality adjustments. In January, the CPI for used vehicles was still up 10% from a year ago. Despite the huge spike in the CPI, the index level is still below where it had been 20 years ago in 2000-2002:

These aggressive hedonic quality adjustments make sure that CPI, and particularly the durable goods CPI, do not reflect actual price changes that consumers face. Consumers understand that they’re getting a better product that costs more to manufacture. But that doesn’t mean that they have the money to buy a new truck, when years earlier consumers with an equivalent income did have the money to buy a new truck.

David Goldsmith

All Powerful Moderator
Staff member

10-Year Treasury Yield Hit 1.21%, More than Doubling Since Aug. But Mortgage Rates Near Record Low. And Junk Bond Yields Dropped to New Record Lows​

Bond Market Smells a Rat: Inflation. So the Fed seems OK with rising long-term Treasury yields.

The bond market smells a rat, but the mortgage market and the high-yield bond market are holding their nose and plowing forward: The 10-year Treasury yield rose to 1.21% on Friday, the highest since February 26, when markets began their gyrations. This yield has more than doubled (+133%) from the historic low of 0.52% on August 4.

In early August, Wall Street hype mongers were still out there pushing the meme that the 10-year yield would fall below zero and be negative for all years to come, in order to entice buyers to buy at that minuscule yield. And had the yield dropped below zero, those buyers would have made some money – especially those with highly leveraged bets.
Alas, when potential buyers need to be enticed with a lower price, which is what began to happen after August 4, the price of that bond falls and therefore the yield rises, and those who’d bought at the lower yields are losing money. For example, at the most basic unleveraged level, the iShares Treasury Bond ETF [TLT], which tracks Treasury securities with at least 20 years of maturity left, fell 1.24% on Friday and is down 14.3% since August 4.

The 30-year yield rose 7 basis points on Friday to 2.01%, the highest since February 19. The yield has more than doubled from 0.99% on March 9.

The Fed has the short-term Treasury yield locked down near zero, via its various interest rate mechanisms and Treasury purchases. Even the yield of the 2-year note is near zero, at 0.109%. With the short end near zero, and the yield at the longer end rising, the yield curve has steepened.
One of the classic measures of the yield curve, the difference between the 2-year yield and the 10-year yield, widened to 1.1 percentage points on Friday, the widest spread since April 2017. That spread had turned negative briefly in August 2019, when the yield curve “inverted” as the 10-year yield dropped below the 2-year yield.

Mortgage rates went in the opposite direction, but are now having second thoughts.

The average 30-year fixed-rate mortgage rate, which generally tracks the 10-year yield, continued dropping after August 4, even as the 10-year Treasury yield was rising. Finally, in early January, it stopped dropping when it hit 2.65%, and has since ticked up a tiny bit. According to data from Freddy Mac, the weekly average as of February 11 was 2.73%.
This chart of the mortgage rate as per Freddie Mac (blue line) and the 10-year Treasury yield shows the disconnect since last summer. But as weekly numbers, they lack the movements over the past two days, when both have risen:

But Junk bond yields continue to drop from record low to record low.​

The average yield per the ICE BofA US High Yield Index, which tracks US-issued junk bonds across the high-yield spectrum, dropped to 4.09%, the lowest in history, going from new low to the next new low, documenting every day the fabulous bubble going on in the riskiest end of the credit markets.

At the upper end of the junk bond markets, the average yield of bonds in the “BB” category (my cheat sheet of corporate bond ratings), fell to 3.19%, according to the ICE BofA BB US High Yield Index, having fallen from historic low to historic low. That’s what 10-year Treasury securities were yielding in October 2018.
But at the upper end of investment grade, average AA-rated corporate bonds have been slowly following the trend set by Treasury securities, but at a much slower pace, having risen just 25 basis points since August 4.

The Fed…

The Fed appears to be OK with rising long-term Treasury yields. Multiple Fed officials have said that if the higher long-term yields are a sign of rising inflation expectations and economic growth – rather than financial stress – they are welcome. And so they’re allowed to rise.
For the Fed, these increases in the long-term Treasury yields and the continued declines in junk bond yields and the near-record-low mortgage rates are a soothing combination, speaking of inflation and not financial stress.
If the spread of junk bonds and mortgage rates to Treasury securities were to blow out suddenly, that would be a sign of financial stress, and might be more worrisome for the Fed.
So the rat that the Treasury market is smelling is consumer price inflation. It’s gnawing its way through various layers of the economy. And the Fed has said that it will ignore inflation for a “while,” and that it will welcome an overshoot of inflation. Only when it becomes “unwanted” inflation, as Powell put it without specifying what that means, would the Fed crack down.
So maybe the Fed would crack down when inflation stays above 4% or 5% for a “while?” Once inflation has solidly set in, it’s hard to stop. That’s the rat the Treasury market is smelling, and if you’re sitting on a bond that yields 1.2% for the next 10 years, that’s not a mouthwatering item on the menu.

David Goldsmith

All Powerful Moderator
Staff member

Global stocks routed as inflation fears dominate​

Global stocks tumbled Friday as a sharp bond selloff encouraged investors to dump riskier assets.
Asian markets followed US stocks lower. Japan's Nikkei 225 (N225) tumbled 4%, while Hong Kong's Hang Seng Index (HSI) closed down 3.6% — that index's worst day in nine months. South Korea's Kospi (KOSPI) dropped 2.8%, while China's Shanghai Composite Index (SHCOMP) lost 2.1%.
European stocks also dropped sharply in early trading. The FTSE 100 (UKX) shed 0.8% in London, while Germany's DAX (DAX) and France's CAC 40 (CAC40) declined by more than 1%.
US stock futures were little changed following heavy losses on Thursday. Dow (INDU) futures added less than 0.1%, while futures for S&P 500 (SPX) and Nasdaq (COMP) were up 0.3%.

Investors around the world are increasingly worried that the wave of pandemic stimulus spending could cause economic growth to accelerate and prices to spike. If inflation takes hold in major economies, central banks could be forced to hike interest rates or curtail asset purchases sooner than expected.

After a long period of easy access to money, that could trigger a market tantrum.

Concerns about higher interest rates are now driving market dynamics, and encouraging investors to dump riskier assets such as tech stocks. Bitcoin prices dropped nearly 4% on Friday, falling below $46,300.

In the United States, the economic outlook has been boosted by the distribution of vaccines, along with the expectation that President Joe Biden will successfully pass a stimulus package through Congress, according to Tai Hui, chief Asia market strategist at JP Morgan Asset Management.

"Investors are now fixated on the risk of inflation and economic overheating," he said.

David Goldsmith

All Powerful Moderator
Staff member

10-year Treasury yield jumps back above 1.5% after Powell comments on inflation​

The 10-year U.S. Treasury yield climbed back above the 1.5% level on Thursday after Fed Chair Jerome Powell said there was potential for a temporary jump in inflation and that he had noticed the recent rise in yields.

The yield on the benchmark 10-year Treasury note rose to 1.541% shortly in afternoon trading. The yield on the 30-year Treasury bond pushed higher to 2.304%. Yields move inversely to prices.


US3MU.S. 3 Month Treasury0.041%+0.0030.00%
US1YU.S. 1 Year Treasury0.081%+0.0020.00%
US2YU.S. 2 Year Treasury0.149%+0.0040.00%
US5YU.S. 5 Year Treasury0.789%+0.0070.00%
US10YU.S. 10 Year Treasury1.563%+0.0130.00%
US30YU.S. 30 Year Treasury2.321%+0.0130.00%
Powell said at the Wall Street Journal jobs summit that the economic reopening could "create some upward pressure on prices." Powell reiterated that the central bank would be "patient" before changing policy even as it saw inflation pick up in what it expects would be a transitory fashion.
The central banker did acknowledge the rapid rise in rates recently caught his attention, but said the Fed would need to see a broader increase across the rate spectrum before considering any action. Yields appeared to move higher after those comments.
The benchmark yield jumped last week, passing both the 1.5% and 1.6% marks to reach its highest level in over a year. The 10-year yield retreated earlier this week, however, and has traded closer to the 1.4% level in recent days.
The 10-year was trading with a yield under 1.0% at the start of the year. Optimism about vaccines, continued federal stimulus and growing concern about inflation have all worked to push bond yields higher in recent months in an unusually rapid move that appears to have rattled the equity markets.
Powell also didn't make a strong hint of any changes in asset purchases by the Fed to contain the rapid increase in rates seen lately, possibly disappointing some investors. Expectations were growing the Fed might implement an "Operation Twist" procedure like it has done in the past where it sells short-term bills and buys longer-duration bonds.

Greg Staples, the head of fixed income North America at DWS, said that Powell was in a tough position as the Fed's stated desire to keep its dovish stance until the economy is near full recovery is contrasted with signs of a strong recovery that could mean some tightening may be a wise choice.

"I don't think that he can reaffirm or even push against the market moves. I think the U.S. Fed is far more reluctant than say the ECB to look at what's going on in the market place, whether it be equity or debt, and say 'this is not where we want it to be,'" Staples said.

"The last thing the Fed wants to do is put themselves in a position where, any time the 10-year sells off by 10 or 15 basis points, they feel like that they have to rush in and buy Treasuries," he added.

The Fed chief said price increases above the Fed's 2% target for a couple quarters or more would not cause consumers' long-term inflation expectations to materially change.

"We have the tools to ensure that long-run inflation expectations are well-anchored at 2%," Powell said.

On the data front, new weekly unemployment insurance claims in the U.S. came in at 745,000 initial claims. Economists surveyed by Dow Jones had projected 750,000 claims.

The initial claims data has improved since the depths of the health crisis and economic restrictions last year, but claims still remain multiples higher than they were in 2019.

Factory orders for January came in at 2.6% growth, beating expectations of 2.3%, according to economists surveyed by Dow Jones.

Auctions were held Thursday for $30 billion of 4-week bills and $35 billion of 8-week bills.