BofA talks us through it:
Rents surge pointing to stronger persistent inflationCore CPI rose 0.24% mom in September, bouncing back from the 0.1%rise in August. This kept the % yoy rate steady at 4.0% (4.03% unrounded) yoy. Headline inflation rose0.41% mom, which bumped up % yoy to 5.4% from 5.3%. Energy prices soared 1.3%mom and food spiked to 0.9% mom.
A major development in this report was a notable acceleration in OER to 0.43% mom and rent of primary residence to 0.45% from its prior 0.2-0.3% mom trend. Given strength in the high frequency rent data, we believed it was only a matter of time before the CPI rent components broke out higher. While one month does not make a trend, this is an early signal of stronger persistent inflation pressures materializing, ultimately supporting continued above-target inflation over the medium term. Medical care was anunderwhelming-0.1% mom as health insurance remained a drag of-1.0% mom—this indicates the BLS did not begin to incorporate the 2020 data just yet, but instead delayed it to October. Outside of health insurance, hospitals cooled to a 0.1% clip and professional services declined by-0.2% mom.
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Core commodities were mixed this month suggesting muted transitory inflation from supply shortages. On one hand, both new cars and household furnishings & supplies rose1.3% mom, education & communication commodities increased 0.6%, and medical commodities were up 0.3%. On the other hand, used cars fell-0.7% mom, appareltanked-1.1% mom amid unfavorable seasonals, and recreation goods decreased-0.2%mom.Used cars may turn higher in coming months as Manheim wholesale prices rebounded, ending a 3-mo streak of declines andmodestly surpassing the prior high.
Reopening pressures were a drag as lodging declined-0.6% mom, airfares slid-6.4%mom, and rental prices fell-2.9% mom. Broader transportation services were down-0.5% mom, with motor vehicle insurance of +2.1% a positive offset.
Overall, the positive surprise in persistent inflation suggests we remain in a hot economy, which could prompt the Fed to move sooner. Meanwhile higher energy and food prices but mixed core commodities may ease some recent concerns about “slowflation.” Transitory prices can turn higher going forward, however, both from supply-shortages and reopening as high frequency data point to an inflection in activity.
The market response was in line with what we would have anticipated given a strong inflation reading all around. The print reflected that while transitory factors continue to roll-off, stickier more persistent factors are becoming more prevalent, which the Fed is more likely to respond to. Consistent with this, nominal rates in the front-end to belly of the curve rose as much as 6bps, though the move has partially retraced, while longer dated tenors were little-changed. The move was concentrated in inflation breakevens though real rates also initially moved higher on the back of the print. Market-implied longer term inflation expectations measured by five-year, five-year inflation breakevens were less than 1bp lower following the print. Policy-sensitive rates rose 4 to 5 bps across 2023 expiries, with the market pricing a modestly steeper near-term trajectory of rate hikes.
Nordea explores the implications:
The upward pressure on prices is currently a clear issue for the average worker and understandably we may be in for a period of higher than usual wage demands from workers to compensate for the development. A net overweight of 30% of small businesses (NFIB survey) plan on raising salaries to compensate for price growth but maybe also to attract skilled labour in a currently tight labour market with remarkably low supply. Usually, the survey results lead wages over the following quarters, suggesting that wage inflation will persist until the beginning of 2023 at the least.
A material benefit is obviously needed to compensate for the bizarre price increases on necessities such as energy and food that we have seen lately. The big question for the Fed is if this turns into a wage to price spiral with continued high inflation in the consumer basket in coming years. The probability of that is now bigger than it has been in years or even decades.
Chart 3. Wage inflation takes off
Jay Powell said at the September meeting that a “reasonably good” job report would be sufficient to initiate the tapering process already at the meeting in November. He did not specify the exact threshold value, but we find that the September job report passed the test as the bar was already low. Tapering is coming in November. What’s more regional public education jobs shrank by 144k jobs in September, which simply cannot be construed as a negative labor market demand story. It is simply either a supply story or else just a poor seasonal adjustment by the statistical bureau during a tricky year to measure employment.
The extreme and swift rise in real estate prices and the accordingly increasing rental expenditures (the rent of shelter inflation lags house sales prices about four to five quarters), makes MBS purchases an obvious first choice in a tapering process, even if both MBS and US Treasury purchases are likely to be scaled down simultaneously. Irrespectively of the order of the asset purchase slowdown, tapering is about to come and will likely further strengthen the USD due to a tighter liquidity picture in to 2022. Due to the tapering scope and the transitory global energy crisis, where the US is relatively better off than Europe and Asia, we remain long USD.
The Fed members have kept asking for a higher Median CPI print before they could truly conclude that they have met the inflation target and they are about to get exactly that into 2022. We will maybe even get the highest Median CPI prints since 1998 according to our adjusted NFIB indicator. This is a whole new scenario for the Fed to deal with and a whole new scenario for markets to deal with as well.
Will the “Fed put” for example prove to be as close to the spot level in equities as we have grown accustomed to over the past decade, if the median inflation numbers are running more than 2% above the inflation target? That is highly debatable, which makes the 2022 risk asset outlook blurry. The inflation mandate is not going to dictate the timing of the rates lift-off, which is still clearly linked to the employment mandate. Employment to population ratios likely need to rebound to levels seen in late 2019 or early 2020 before a hike can even be barely debated, but that is clearly a scenario that is in play for H2-2022 as markets have now also priced in. The scope to reprice the Fed in an aggressive direction is now less clear than it was a couple of quarters ago.
Chart 4. Median CPI increases? Wait for it..
Underlying US inflation strength only intensifies my fears of a commodities and EM bust in 2022.