May 25. We’re at the point of absurdity
–Interesting quote from Lawrence Lindsey at last week’s Peterson Econ Conference: “We’re at the point of absurdity. Maybe it made sense [ZIRP] when you had a crisis. It does not make sense now. At some point what is going to happen – and this gets to my eight or nine cataclysmic number [on a scale of 1 to 10] – is that we’re going to get a series of bad numbers – a little higher inflation, higher average hourly earnings or whatever – and the market is suddenly going to say, “Oh my God, they are so far behind the curve that they will never catch up.” And the market is going to force an adjustment on the Fed that will be wrenching. That’s the cataclysmic outcome.”
–I don’t know what the timing of such a cataclysmic event might be. However, the reaction to Friday’s Core CPI data at +0.3 seems significant (short end selling; see below). Given improvement in employment data, inflation is the final piece of the puzzle to move rates off the zero bound. Another interesting nugget in Friday’s inflation number is the rise in “sticky prices”. From the Cleveland Fed: “The sticky-price CPI includes many service-based categories, including medical services, education, and personal care services, as well as most of the housing categories which, by construction, change only infrequently.” Some economists believe changes in sticky prices give a better sense of trend with regard to inflation. Friday: ANNUALIZED STICKY-PRICE CPI ROSE 3.5%. Yoy it was up 2.1%, and has been above 2% since last August.
–Yellen, in her comments Friday noted that “…output and job growth over the next few years could prove to be stronger, and inflation higher than I expect, correspondingly, employment could grow more slowly and inflation could remain undesirably low.” There’s another scenario…lower growth and higher inflation. That’s probably the combination to really worry about.
–Inflation is now becoming the market’s main focus. The curve flattened Friday as higher than expected Core CPI of +0.3 sparked a significant reaction in short end contracts. Green eurodollars (3rd year) were the weakest part of the curve, falling 7.5 bps on the day. The two year note rose 4.6 bps, fives 6.4 bps, but tens rose only 3bps and thirty year bonds just 1.
–There were a couple of large option trades which expressed renewed hawkishness on the front end. A buyer of 20k July 9950/9937p spreads for 1.0 and a buyer of 20k EDZ5 9950/9925p 1×2 for 5.0 bps (settled 5.0 ref 9940). This week features auctions of 2’s, 5’s and 7’s. Durable today expected -0.6 with ex-transport +0.4.
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SOURCES:
https://www.frbatlanta.org/research/inflationproject/stickyprice.aspx
https://www.clevelandfed.org/Newsroom%20and%20Events/Publications/Economic%20Commentary/2010/2010-02%20Are%20Some%20Prices%20in%20the%20CPI%20More%20Forward%20Looking%20than%20Others%20We%20Think%20So
http://research.stlouisfed.org/fred2/series/STICKCPIM159SFRBATL
