The Week Ahead – Inflation is coming

The Week Ahead – Inflation is coming

The Week Ahead – Inflation is coming

The opening few months of 2018 have seen the return of volatility to global financial markets. It is important to stress that US economic fundamentals have remained broadly the same. The rise in Treasury yields are a healthy development as long term rates have been too low relative to the strength of activity in the US economy and globally. I still believe the outlook for the US economy remains constructive with little evidence of overheating. Additional bouts of volatility should not be feared.

Inflation is coming and the charts below of the Steel ETF (SLX) and the Agribusiness ETF (MOO) show price action at breakout levels. This cyclical uptuen in global growth is translating into normal levels of inflation and interest rates. Reverting to the old normal i guess.

steel slx

 

Previous week: 19 February 2018 – 23 February 2018

RBA Monetary Policy Meeting Minutes—8.30am 20 February 2018 Tuesday

Weak (gradual) inflation continues to keep the central bank from tightening their monetary policy. Just a reminder, “the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over time.”

From the minutes for meeting dated 6 February 2018 with regards to inflation:

  • The inflation data for the December quarter had been in line with the forecasts presented in the November Statement on Monetary Policy. Trimmed mean inflation had been 0.4 per cent in the quarter and 8 per cent in year-ended terms. Headline inflation had picked up a little in the quarter to 0.6 per cent and 1.9 per cent in year-ended terms.

 

  • The recent data had not materially changed the outlook for inflation. The forecast was for underlying inflation to increase gradually to around 2¼ per cent by mid 2020, partly in response to expected faster growth in labour costs as spare capacity in the labour market is absorbed. Headline inflation was expected to be higher than underlying inflation, partly because of scheduled increases in the tobacco excise.

 

  • Over 2017, progress had been made in reducing the unemployment rate and bringing inflation closer to target. The low level of interest rates was continuing to play a role in achieving this outcome. Further progress on these goals was expected over the period ahead but the increase in inflation was likely to occur only gradually as the economy strengthened; the Bank’s central forecast for the Australian economy was for GDP growth to pick up to average a little above 3 per cent over the next two years and for CPI inflation to be a little above 2 per cent in 2018. Members observed that an appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than forecast.

On cryptocurrencies: Hmmm…

  • Members were briefed on the emergence of cryptocurrencies and on developments in distributed ledger technology more broadly, as well as their implications for the financial system. They discussed how these developments might affect the operation of the financial system and the potential technical and policy issues that might emerge for central banks and other regulators.

http://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/2018-02-06.html

FOMC Meeting Minutes—3am 22 February 2018 Thursday

Summary: Inflation will rise! Economic growth is strong! Labour market is tight! We don’t have a clue on wage growth. Further (and not faster) gradual policy firming would be appropriate.

Committee’s discussion on inflation:

  • “On a 12-month basis, both overall inflation and inflation for items other than food and energy continued to run below 2 percent. Market-based measures of inflation compensation increased in recent months but remained low; survey-based measures of longer-term inflation expectations were little changed, on balance.”

 

This is a fact based on hard historical data, not an opinion of members of the committee.

 

  • “Near-term risks to the economic outlook appeared roughly balanced. Inflation on a 12-month basis was expected to move up this year and to stabilize around the Committee’s 2 percent objective over the medium term. However, participants judged that it was important to continue to monitor inflation developments closely.”

 

This is a prediction by the committee. They believe / forecast / expect / anticipate that inflation will rise in the coming year and settle around 2%.

 

  • “In their discussion of inflation developments, many participants noted that inflation data in recent months had generally pointed to a gradual rise in inflation, as the 12-month core PCE price inflation rose to 1.5 percent in December, up 0.2 percentage point from the low recorded in the summer. Meanwhile, total PCE price inflation was 1.7 percent over the same 12-month period. Participants anticipated that inflation would continue to gradually rise as resource utilization tightened further and as wage pressures became more apparent; several expected that declines in the foreign exchange value of the dollar in recent months would also likely help return inflation to 2 percent over the medium term.”

 

Participants that believe that inflation will rise in the coming year gave their justification for their stance. Their justifications are that resource utilization will continue tightening, wages will continue rising, and a weak US dollar will lead to imported inflation.

 

  • “Many participants thought that inflation expectations remained well anchored and would support the gradual return of inflation to the Committee’s 2 per-cent objective over the medium term. However, a few other participants pointed to the record of inflation consistently running below the Committee’s 2 percent objective over recent years and expressed the concern that longer-run inflation expectations may have slipped below levels consistent with that objective.”

 

A few participants read the inflation tape and called the bluff of the majority. Core PCE inflation had never been at or above the 2% target for a sustained duration since the Great Recession. The opinions of the minority is duly noted but it does not change the current narrative of the majority, which is everything is beautiful and rosy in inflation land.

 

  • Almost all participants continued to anticipate that inflation would move up to the Committee’s 2 percent objective over the medium term as economic growth remained above trend and the labor market stayed strong; several commented that recent developments had increased their confidence in the outlook for further progress toward the Committee’s 2 percent inflation objective. A couple noted that a step-up in the pace of economic growth could tighten labor market conditions even more than they currently anticipated, posing risks to inflation and financial stability associated with substantially overshooting full employment. However, some participants saw an appreciable risk that inflation would continue to fall short of the Committee’s objective. These participants saw little solid evidence that the strength of economic activity and the labor market was showing through to significant wage or inflation pressures. They judged that the Committee could afford to be patient in deciding whether to increase the target range for the federal funds rate in order to support further strengthening of the labor market and allow participants to assess whether incoming information on inflation showed that it was solidly on a track toward the Committee’s objective.”

 

“Almost all” participants see inflation rising towards the 2% target. “Several” said “recent developments had increased their confidence in the outlook”. I suppose these “recent developments” refer to recent tax cutting law. “A couple” thought that economic growth will be so robust that inflation will overshoot their target. “Some participants” thought that inflation will remain tepid and will fall short of their target.

Committee’s discussion on the economy:

  • “Participants generally saw incoming information on economic activity and the labor market as consistent with continued above-trend economic growth and a further strengthening in labor market conditions, with the recent solid gains in household and business spending indicating substantial underlying economic momentum. They pointed to accommodative financial conditions, the recently enacted tax legislation, and an improved global economic outlook as factors likely to support economic growth over coming quarters. Participants expected that with further gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor market conditions would remain strong.”

 

The economy is STRONG!!!!

Committee’s discussion on wage growth:

  • “During their discussion of labor market conditions, participants expressed a range of views about recent wage developments. While some participants heard more reports of wage pressures from their business contacts over the intermeeting period, participants generally noted few signs of a broad-based pickup in wage growth in available data. With regard to how firms might use part of their tax savings to boost compensation, a few participants suggested that such a boost could be in the form of onetime bonuses or variable pay rather than a permanent increase in wage structures. It was noted that the pace of wage gains might not increase appreciably if productivity growth remains low. That said, a number of participants judged that the continued tightening in labor markets was likely to translate into faster wage increases at some point.”

 

The committee’s does not have a consistent opinion on wage growth, probably because they do not have a handle on this issue at hand. Their business contacts / friends (on the street called Wall) says wages are rising. However hard data provided by the government disagrees. There is “few signs of a broad-based pick up in wage growth in available data”. “Few participants” say that employees will receive a one-off temporary bonus and not permanent wage rises. How about the other participants’ opinions? What are their opinions on tax savings boosting compensation? Despite the importance of the tax cuts to wages, none is mentioned by the committee apart from a “few participants”. “A number of participants” continue to believe that the tightening labour market will lead to rising wages “at some point”. When will that ambiguous point be? 2018? 2019? 2100? On what basis are they basing their opinion / hope on? The hard data in their own words showed “few signs” of wage growth. In the words of President Obama, “I still believe in hope”. Keep having this mentality and Brexit states (Wisconsin, Pennsylvania, Michigan, and Ohio) will continue staying Red.

Committee’s discussion on interest rates:

  • “Several others suggested that the upside risks to the near-term outlook for economic activity may have increased. A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate.”

 

From Zerohedge / Bloomberg: “Further” does not equal “faster” in the FOMC minutes… at least not in 2018. Policy makers appear willing to maintain their projected pace of three rate hikes this year, but perhaps to extend this pace further into the future in light of stronger growth prospects due to fiscal policy.

https://www.federalreserve.gov/newsevents/pressreleases/monetary20180221a.htm

https://www.zerohedge.com/news/2018-02-21/fomc-minutes-signal-further-rate-hikes-fear-elevated-asset-valuations

US Crude oil inventories—12 am 23 February 2018 Friday

US crude inventories DECREASED by -1.616 million barrels on the expectation of +2.35 million increase. Baker Hughes US oil rig count increased by 1 from 798 to 799. Oil production was 10270k barrels per day for week ending 16/02/2018, a decrease from 10271k barrels per day in the previous week. US Oil production still remains at / near all time and have just overtaken Saudi Arabia and is expected to overtake Russia in due time. The rise in rig count is attributed to the strong correlation to the price of oil. The head on battle between US and OPEC continues. Frackers are churning out their rigs while OPEC is keeping a lid on production.

Image taken from Zerohedge:

https://www.zerohedge.com/news/2018-02-22/wtirbob-jump-after-doe-confirms-surprise-crude-draw-production-slows

https://www.reuters.com/article/us-usa-rigs-bakerhughes/u-s-oil-rig-count-rises-for-fifth-straight-week-baker-hughes-idUSKCN1G72F5

https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCRFPUS2&f=W

Japan core inflation, or the lack of

Core inflation rose by +0.9% in January 2018 from a year earlier, which is the same rate as the previous 2 months. Headline inflation rose by +1.4% in January from a year earlier, a 34 month high. The first sentence of the article written by Reuters summarises the predicament the BOJ is in. “A recent Reuters poll showed more than half of Japanese firms do not plan to raise base pay in annual wages talks this year, and the recent market sell-off could give them further excuse to delay pay hikes.”

https://www.reuters.com/article/us-japan-economy-cpi/japans-stagnant-inflation-set-to-keep-boj-exit-from-stimulus-distant-idUSKCN1G6307?il=0

US embassy to move to Jerusalem in May

Quoting the first line of the CNN article: “The Trump administration will move its US Embassy in Israel from Tel Aviv to Jerusalem in May, the State Department announced Friday, coinciding with Israel’s 70th anniversary.” Two state solution is no more. It is now a one state solution even if the State of Palestine is a current non-voting member of the United Nations.

https://edition.cnn.com/2018/02/23/politics/us-embassy-jerusalem-move-may/index.html

Coming week: 26 February 2018 – 02 March 2018

US Crude oil inventories—11:30 am 28 February 2018 Wednesday

Inventories will continue to build up and crude prices will consequently fall.

Trade Ideas

USD/JPY short

USD/JPY broke a key support at 108 last week. Retracement back up to 108 will give a good opportunity to go short with potential target at 101.

Short USD/CAD

On the weekly chart, USD/CAD seem to have hit a resistance at 1.27. The rising price of crude oil will provide tailwind for the Canadian Dollar to strengthen.

 

 

 

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