Mark Carney remains trapped in his self imposed monetary mess where he can’t even find the will to at least take back the emergency rate cut after Brexit even though his economic estimates were wildly wrong and now he has an inflation problem relative to wages. Responding to the slowly growing mutiny in the MPC he said “Now is not yet the time to begin that adjustment. I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.” The pound immediately fell and the 2 yr Gilt yield is lower by 4 bps to .135%, giving back half of the rise after 3 members last Thursday wanted to raise rates. I get Carney’s worry about Brexit but this is a multi year process where life will going on regardless and business will do their thing. Instead, the average UK citizen is currently being damaged by falling real wages that can be mitigated by a modest rise in short term rates. As a reminder too, the unemployment rate in the UK is at the lowest level since 1975 with the benchmark rate at the microscopic .25%.
The United States
Chicago Fed President Charles Evans, a man obsessed with delivering a higher cost of living and a voting member, raised the possibility of maybe waiting for December for the next rate hike if inflation doesn’t rebound. He does though agree with beginning the process of QT, believing it won’t be a big deal. As it is another form of tightening, it will be a big deal even though the process does need to begin. The 2 yr note is not responding to Evans rate comment as its holding its yield gain yesterday after Dudley was more hawkish.
As a follow on to what I said yesterday on inflation, whether it’s the CPI or the PCE, they are being artificially depressed by 3 things which if better measured, would have given the Fed their inflation desires long ago. 1)The heavy rent component within CPI (25%) is measured by Owners Equivalent Rent which asks homeowners what they think they’d be able to rent their house for. It always understates what actual rent growth is as measured by Rent of Primary Residence (just 7% of CPI). 2)Healthcare in PCE focuses on medicare/Medicaid reimbursement rates which are price fixed by the government and just ask any Doctor how depressed those payments are. And 3)hedonically adjusting a technological improvement in a product is quite subjective. Here is an example on this last point. The average price of a new car in the year 2000 was $24,750 vs $34,075 last year (according to Edmonds), an increase of 38%. The CPI component says the price since the beginning of 2000 thru 2016 was up a grand total of 3.6%, thanks to hedonics.
Speaking of the 2 yr note yield, it sits just 1.5 bps from a 9 yr high. While the 2s/10s spread is a focus of many, yesterday the 5s/30s spread fell 4 bps to the lowest level since December 2007. While the curve can certainly flatten much further before it matters, the current trajectory seems pretty clear.
As energy prices are now turning down, German PPI was lower by .2% m/o/m in May. Ex energy wholesale prices were up by .1%, a slowdown from recent months. Prices though were still up 2.8% y/o/y and 2.7% ex energy. This number is never market moving and the euro is unchanged with bund yields a hair lower. With QE scheduled to end in December, which will of course get pushed into 2018, the ECB will have no choice but to update us on their plans in coming months. Mario Draghi though is clearly afraid of the repercussions at the same time he is not happy that inflation is not closer to his 2% goal.