Peekaboo Inflation: Now You See It, Now You Don’t.

Signs of Inflation Rapidly Vanish.

For the 12 months ended September, 2018, the Consumer Price Index (CPI) was reported to be increasing at an annual rate of 2.3% (https://www.bls.gov/cpi/).  The CPI is the “official” measure of how much more it costs an individual each year to maintain a consistent standard of living.

Unfortunately, the CPI is extremely politicized and very prone to “adjustments” by the Federal Government, which has every incentive to keep a lid on the actual, reported number.  An annual CPI adjustment is “built-in” to almost all government outlays such as entitlement spending, benefits, salaries, and pensions.

There remains much anecdotal evidence that “experienced” inflation is substantially higher than the reported figure which makes the “News”.  For additional background, this topic was covered in more detail in: “Inflection Point (Part 5): Interest Rates, Inflation, and Inflection” (https://markonomics101.com/2018/09/03/inflection-point-part-5-interest-rates-inflation-and-inflection/)

Recently, a handful of signs appeared, suggesting the increased likelihood of inflation on the not-so-distant horizon: “Inflation: Suddenly, the Signs are Everywhere!”  (https://markonomics101.com/2018/09/26/inflation-suddenly-the-signs-are-everywhere/).  Admittedly, they were only “Signs”.  

Now, most of those signs of inflation have simultaneously vanished.

Suddenly, Signs of Inflation are Nowhere.

The CPI can easily be toyed with, adjusted, massaged, spindled, or mutilated before being released officially.  It should, therefore, be viewed with skepticism and in the context of being a questionable number.

On the other hand, the various markets which reflect inflationary expectations are just TOO LARGE to be successfully manipulated in combination for very long.  The market-based signs are clear.

The first set of slides below offers not a shred of evidence of over-heating inflation whatsoever.  The US Dollar Index (USD) continues to strengthen.  A rising currency level is by itself, nearly enough to exclude the prospect of rising inflation as a problem.  Inflation is, by definition, a devaluing currency!  

Earlier this year, commodity prices appeared to be showing some upward strength, led by higher prices in the energy sector.  A glance at the Commodity Research Bureau Index (CRB) suggests whatever strength HAD appeared to exist, no longer does.

 

 

While rising energy prices appeared to be providing the basic leadership within the commodity sector, the benchmark West Texas Intermediate Crude (WTIC) has now fallen nearly 20% in the just the last month.  Neither Gold (GLD) nor Silver (SLV) are screaming inflation in their charts.  In fact, Precious Metals are not even whispering inflation.

Treasury Inflation Protected Securities (TIPS) Scream “No Inflation”.

Possibly, the most straightforward measure of inflationary expectations can be found in the “Treasury Inflation Protected Securities” (TIPS).  TIPS are structured and priced to provide a means for investors to earn a “real” (after inflation) return.  TIPS are priced to reflect a “premium”, thereby yielding a rate above the current CPI.

TIPS rise when investors seek a greater level of return premium to keep pace with measured inflation.  When fears of higher inflation subside, the premium subsides, and TIPS decline in price.

 

The chart above indicates any near-term explosion in inflation is very unlikely.

Yet, Interest Rates Are Rising?

In an environment showing low and falling inflation, one would normally expect bond yields to be falling.  They are not.  In fact, the yields on 30-year maturities (TYX) recently moved to new multi-year highs, while 10-year maturities were just below these levels.  Both chart patterns, included in the slideshow above, illustrate a pattern consistent with a strong uptrend in rates.

More Anecdotal Evidence of Inflation Comes from Corporate America.

While the case for no-to-low inflation seems pretty solid, anecdotal evidence continues to suggest something is brewing.  Much of this has come from Corporate America and 3rd quarter earnings reports.  Retailer Kohl’s recently reported that both tariffs (which are inflationary) and higher wages (which are also inflationary) had put pressure on earnings (https://www.cnbc.com/2018/10/30/kohls-ceo-on-wage-pressures-tariffs-and-the-effect-on-pricing.html).

Corporate giant Amazon (AMZN) recently announced an increase in base pay for its employees to $15 per hour, in line with the “Living Wage” and level sought by politicians.   Amazon is a large employer for whom paying substantially higher wages WILL hurt the bottom line.  While suggesting the raise was for “humanitarian” reasons, more likely is that the decision is a necessary reflection of the difficulty in finding labor in the current economy, for LESS.

Amazon’s increased pay rate will impact every retailer’s bottom line  (https://www.wsj.com/articles/amazons-wage-increase-adds-pressure-for-employers-to-boost-pay-1538518368).

The timing of Amazon’s move was carefully calculated.  The upcoming Holiday Season is expected to be very strong and the availability of seasonal employees is more limited than in recent history.  In fact, the entire cost structure of retail will be affected and the price impact will absolutely be passed on to consumers.  Will it end up being reflected in the CPI?

Tariffs Eat into 3rd Quarter Earnings.

Corporate America is reporting an overall substantially net negative impact from Tariffs in large numbers.  According to CNBC, Tariffs were directly or indirectly attributed as a negative factor nearly 40% of the time.  Many companies have substantially rearranged production schedules to either “front run” the impact of tariffs scheduled to be levied or to minimize the anticipated future impact (https://www.cnbc.com/2018/10/24/more-than-one-third-of-sp-500-reporting-earnings-are-talking-tariffs.html).

 

Clearly, it remains to be seen whether, and on what scale, we experience the inflationary phenomena.  It is possible the inner workings of inflation are being slowly digested by the economy, only to become more obvious later.  Nevertheless, higher rates will be a positive for savers who have had few attractive, yield alternatives.

For now, the best strategy remains, using available market opportunities to reduce one’s personal exposure to the inherent risks faced.  A good start on how to accomplish this can be reviewed here: “How To Survive, Prosper and Thrive in the Coming Bear Market” (https://markonomics101.com/2018/10/09/how-to-survive-prosper-and-thrive-in-the-coming-bear-market-part-1/).

 

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