Fed Inflation Targets, CPI, Housing Starts, Industrial Production

I posted some commentary over at CNBC.com about the possibility of the Fed raising inflation targets. Here’s a taste:

I can’t let an opportunity go by without criticizing a Fed official. I believe their feet should be held to the fire after creating a huge asset price bubble and culture of debt that is dragging down economic growth.

 Fed President John Williams comments yesterday really got me angry. First, he suggested possibly raising the Fed’s 2 percent inflation target. This reflects an amazing cluelessness of the damage this would do if realized.

We are in an epic bond bubble globally where higher inflation would be kryptonite. With the bond monster central bankers have created, the last thing they should want is higher inflation. Also, many U.S. citizens are literally living paycheck to paycheck and a higher cost of living without a corresponding increase in wages or any interest income would damage the largest component of the U.S. economy and the lives of millions.

You can read the rest here. Betting on higher inflation in coming years is the best non consensus trade out there I believe.

Elsewhere, wow, that was quick. The plunge in the pound in late June and into July led to a spike in wholesale prices in the UK. Input prices rose 3.3% m/o/m and 4.3% y/o/y, well above the estimate of up 1% and 2% respectively. The almost 4% increase m/o/m in the price of materials purchased was the main catalyst. Output prices didn’t come close to offsetting this as they only rose .3% m/o/m and the same y/o/y. As for consumer prices, it will take some more time for the weak pound to filter through but if the PPI figure is any indication, it certainly will and possibly in a sharp way. CPI rose .6% m/o/m, one tenth more than expected and the quickest since November 2014 as commodity prices have bottomed. The core rate was up by 1.3%, one tenth less than the forecast.

Bottom line, the monetary lunch being served is never free. Whatever benefit Mark Carney and his colleagues think ever lower interest rates and a weaker pound will create will be offset by starved savers, dying retirement products and a higher cost of living for the UK populace. The pound is up by .7% vs the US dollar but the Gilt market is calm with the 10 yr yield unchanged. The FTSE 100 is lower on the stronger pound.

The dollar weakness is not just against the pound, it is getting slammed against everyone else. In particular, the yen is breaking below 100 and on a closing basis this is the highest level vs the dollar since November 2013. The Nikkei fell 1.6% overnight. The euro is near a two month high and the Bloomberg Asian currency index is at a 2 ½ month high vs the US dollar. Gold as a result is back above $1350.

Back here in the U.S., July CPI was flat headline as expected and rose .1% core which was one tenth less than expected. On a y/o/y basis, prices were up .8% headline and 2.2% core, both one tenth less than expected. That core rate though is the 9^th month in a row above 2% but nothing to see here because the Fed says they only look at PCE. Rent and medical care remain major cost issues. Rent of Primary Residence rose another .3% m/o/m and up 3.8% y/o/y. Owners’ Equivalent Rent was also up by .3% m/o/m and 3.3% y/o/y. OER is a faux measure of rent inflation and if actual rents paid were used and also made up 24% of CPI, inflation would print higher. Medical care costs increased by .5% m/o/m and 4% y/o/y. Also, nothing to see here because the Fed looks at the medical care component of PCE which is price fixed because it measures medicare/Medicaid pricing rather than actual out of pocket costs that CPI measures. Keeping a lid on inflation was no change in prices m/o/m for clothing and a 1% decline in used car prices which have fallen for a 3^rd straight month (which will start to impact new car sales soon). New car prices rose .2%. Energy prices fell 1.6% m/o/m and 11% y/o/y. Food prices were flat m/o/m and up .3% y/o/y.

Bottom line, because the Fed looks at PCE instead of CPI, they can tell themselves that they haven’t met their inflation objectives and thus rationalize a fed funds rate of just .375%. For the rest of us who look at CPI, they have for 9 straight months. As today’s data was about in line, treasuries are about unchanged. I continue to believe we’ve seen the low in global interest rates.

Housing starts totaled 1.211mm, 31k more than expected and up from 1.186mm in June. Most of the upside, again, was in multi family as starts there rose by 21k m/o/m to 441k vs 387k one year ago. Single family starts were up by 4k to 770k. They totaled 760k in July 2015. The same story was seen in permits where single family permits fell by 27k to the lowest level since September 2015 while multi family permits were higher by 26k to the most in six months.

Bottom line, single family starts of 770k is about exactly where the year to date average is of 773k, 25% below the 25 year average and 58% below the 2006 peak. Yes, we continue to be in a housing recovery but let’s put it into perspective. Also, the market needs more lower priced homes to be compete with renting. With respect to renting, all the multi family supply coming on line should temper rent increases from here in certain markets. We are already seeing evidence of that in San Francisco and New York City.

Industrial production in July rose by .7% m/o/m, three tenths more than expected but partially offset by a two tenths downward revision to June. May was revised up by one tenth. Manufacturing production was up by .5%, two tenths more than expected and driven by a 1.9% m/o/m gain in auto production. The production of machinery and computer/electronics also rose. Weather related utility output also boosted the headline figure. Mining production rose too by .7% but remains down by 10% y/o/y. Capacity utilization improved to 75.9% but much of that was a multi month high in utility utilization. Auto utilization also improved to 84.4%, also a multi month high.

Bottom line, it was good to see some improvement in manufacturing and mining production in July. On the former, the sustainability will be in part attributable to auto sales where worries about a peak are apparent and thus the same with the production of them. The manufacturing production index is at 103.6 which has basically flat lined since November 2014 when it touched 103.5. The pre recession peak was 109.5 in January ’08. Mining production I believe has bottomed coincident with the bottom in commodity prices. As for markets, IP is rarely market moving but Treasury yields did move to the highs of the morning after the beat with the 10 yr at 1.56%. European yields are also at the highs of the day.

As for Bill Dudley’s comment that September is a possibility for a rate hike, the October fed funds futures contract capturing the September meeting has priced in a 22% chance of this. We are at 42% odds by year end. The 2 yr yield though is at a 3 week high.