Stronger inflation data in the US again fuels the ‘transitory-versus-persistent’ debate on the fundamental nature of inflationary pressures. It is a discussion that has further to run. Although as fickle as ever, bond markets seem to be adhering to the ‘transitory’ school of thought.
New cases have continued to climb around the world and are now at 440 000 per day, up from 390 000 last week. A rise in cases in Asia, Europe, and North America has offset a decline in South America over the past week. In the UK, where the Covid situation is considered to be 8-12 weeks ahead of continental Europe, new cases have accelerated to above 30 000 per day.
For advanced economies with better vaccine coverage, the consensus view for the moment appears to be that the spread of the Delta variant will not translate into renewed lockdowns. This analysis is supported by the still low hospitalisation rates. A more significant risk is arguably that rising case numbers dampen consumer confidence and delay the recovery in household spending.
In the US, a voting member of the rate-setting Federal Open Markets Committee warned last week that the spread of the Delta variant and low vaccination rates in some parts of the world threatened the global recovery. Mary Daly urged caution in removing monetary support for the US economy and suggested one of the biggest risks to global growth was a premature declaration of victory over Covid. The president of the Federal Reserve Bank of San Francisco went on to warn that if the global economy cannot boost vaccination rates to overcome Covid rapidly, US growth faced a headwind.
The minutes for the June meeting of the FOMC offered no additional hawkish elements to further roil markets which had not expected US central bank officials to predict they would be raising interest rates sooner and more aggressively than they had signalled earlier this year.
If anything, in the minutes, FOMC participants messaged caution when assessing economic progress and the odds of the Fed tapering its asset purchases, while underscoring uncertainty and the associated high bar for decision-making.
Fed Chair Jay Powell is expected to deliver a similar message to Congress this week ahead of the FOMC meeting on 25-27 July.
Data published this week showed the pace of US consumer price increases accelerated unexpectedly in June. This challenges the view within the Fed that high inflation during the US recovery will be temporary. The consumer price index rose at the fastest pace since August 2008, up by 5.4% from the previous year. This is well above the 5% rise reported in May and the 4.9% consensus forecast.
On a monthly basis, prices rose by 0.9% for the biggest single-month jump since June 2008. The core data (stripping out volatile items such as food and energy) showed US inflation rose from 3.8% YoY in May to 4.5% in June.
Price rises have so far been most significant in sectors directly affected by the coronavirus pandemic.
Exhibit 1: US core inflation rose by more than expected in June – graph shows month-on-month changes for US consumer price inflation less food and energy prices
Source: BNP Paribas Asset Management, Bloomberg as of 13/07/2021
Travel-related expenses such as airfares have soared, while a semiconductor shortage has contributed to a jump in the prices of used cars. One-third of the rise in the CPI in June was due to a record jump in previously-owned car prices. They rose by 10.5% in June from the previous month.
The report shows reopening-sensitive sectors (used cars, rental cars, vehicle insurance, lodging, airfares, and food away from home) dominating price pressures for a third straight month.
Car prices, especially used car prices, have been surging thanks to a combination of high demand from rental car companies (who let their fleets dwindle in the early months of the pandemic), buying appetite boosting stimulus cheques from the administration and severe (semiconductor) bottlenecks in car production.
Auction data for used cars suggests the worst of the price pressures should be behind us soon, and media reports from Taiwan say that waiting times for semiconductors for use in automobiles are shrinking. Taken together, that implies price pressure should ease in the months ahead.
One area where prices are rising for non-transitory reasons is in housing. House prices are hitting the roof as upper income consumers, flush with savings and benefiting from very low mortgage rates, search for property. However, as asset prices, these have no more place in the CPI than equity prices do. What matters for inflation is rents. These have begun to pick up as the labour market improves.
The Fed has continued to characterise rising inflation as ‘transitory’. The pressures should fade as Covid-19 lockdowns ease further and supply catches up with pent-up demand. At their meeting in June, Fed officials predicted that their preferred gauge of core inflation would rise by 3% this year, before falling back down to 2.1% in 2022.
This latest surprisingly high inflation report could put pressure on the Fed to consider slowing monetary stimulus by reducing its asset purchases more quickly than previously thought. Should the Fed continue to make quantitative easing (QE) asset purchases of USD 120bn per month? Chair Powell’s testimony to Congress on Thursday (and the August Jackson Hole conference) could provide opportunities for hints with regard to an upcoming taper.
US government bonds seesawed after the strong inflation data: yields initially rose further from the lows (at 1.25% last week) seen since the Fed’s monetary policy meeting in June and its ‘dot plot’ forecasts which had been as hawkish.
Subsequently, a weak auction of 30-year US Treasury debt jolted markets. Yields of the benchmark 10-year US Treasury rose by 0.05 percentage points on the day to 1.42%.
In the second week of March 2020, the Organisation of Petroleum Exporting Countries (known as OPEC, but expanded to ‘OPEC+’ after Russia joined its deliberations) held a disastrous meeting in which it failed to agree on production levels. As a result, the oil price plummeted.
Last week, OPEC+ again failed to reach an agreement on production increases. The result, this time, has been to push the oil price upward. Brent crude has now risen by almost 400% since last year’s low and at USD 76/barrel, it is approaching its peak from 2018.
The rise in oil prices is expected to lift inflation further globally. Moreover, the recent rebound in oil prices will continue to support inflows into energy-related stocks and the US high-yield energy sector.
Retail sales data is expected to show elevated growth in June, with the consensus expecting a 0.4% month-on-month (MoM) rebound.
The bottom line remains that retail sales are well above their pre-Covid trend. We also note that as the economy continues to reopen and normalise, services will likely comprise the bulk of the catch-up in consumer spending.
In the past, the European Central Bank was generally considered to have a slightly hawkish tilt (relative to other central banks). Its mandate for price stability was interpreted as calling for inflation to remain close to, but below 2%. The ECB’s strategy review, its first since 2003, has resulted in a modest update, aimed at making its goals clearer.
From now on, the ECB will now have a symmetric inflation target; inflation that is either below or above 2% will be ‘equally undesirable’. Additionally, the ECB will tolerate a transitory period of ‘overshooting’ if a sustained period of near-zero interest rates threatens the central bank’s credibility in hitting its inflation target.
This new target arguably does away with any hawkish bias that may have contributed to the ECB consistently undershooting its inflation target since the 2008 financial crisis. ECB President Lagarde confirmed that unconventional tools such as QE would remain part of the ECB’s armoury.
This shift represents an adjustment rather than an overhaul of ECB monetary policy. For example, unlike the Fed, the ECB will not target ‘average inflation’, allowing prices to rise faster to compensate for past shortfalls. A change to include housing in its chosen measure of inflation is limited to the cost of owner-occupied housing — which usually changes only modestly year-to-year — rather than actual house prices.
Last but certainly not least, a ‘climate action plan’ aims to ensure that companies whose bonds the ECB purchases are acting in line with the goals of the Paris climate accords.
To counter China’s current economic slowdown, the People’s Bank of China has cut the reserve requirement ratio (RRR) to enhance support for the real economy and micro, small and medium-sized businesses.
The news was a positive surprise to the market given the contraction in credit and the economic slowdown over recent owing to tardy fiscal expenditure and tightening policies in the property and internet space. The central bank’s move was seen as pre-emptive. It suggests room for manoeuvre should the challenges worsen.
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