Parts of the global economy continue to face new lockdowns because the pandemic is not over. But the endgame still appears to be the availability of effective medical vaccines, which will allow economic re-openings. The U.S. is providing further evidence. Recent U.S. economic data has been strong overall. Retail sales surged +9.8% m/m in March, initial jobless claims plunged to 576,000 last week (the lowest since the pandemic hit last year). The NY Fed manufacturing index rose to 26.3 in April and the Philly Fed index remained solid at 50.2 (!). The NAHB homebuilders index was a strong reading of 83 in April. The Atlanta Fed’s tracking estimate for 1Q real GDP is up to +8.3% q/q A.R.
Factories are having trouble keeping up. Industrial production rose +1.4% m/m in March, which isn’t terrible, but after weather-related disruptions in February could have been even stronger. The Fed’s Beige Book characterized the U.S. situation as: “national economic activity accelerated to a moderate pace from late February to early April.” That sounds more like the industrial data vs. the consumer surge. Production should continue to ramp in the coming months.
With this backdrop, inflation is increasing. As the “square-root” economic recovery continues to turn into a delayed “V” in the U.S., it is being accompanied by an upturn in inflation in 2021 (base effects y/y + bottlenecks). Pipeline inflation pressure has been building in PPI readings. The U.S. CPI rose 0.6% m/m in March, with the core CPI up 0.3%. The headline was up 2.6% y/y with the core up 1.6% vs. a year ago. U.S. base effects will last thru May, indicating that CPI readings are likely to continue to trend higher due to year over year comparisons. Thus far, outsize increases in U.S. inflation look tied to reopening (hotels, rental cars, recreation, insurance, etc). To be fair, markets appear to have anticipated the beginning of this inflation scare. 10-year Treasury yields ended last week at 1.58%.
Central banks remain committed to easy monetary policy, as millions remain unemployed. Fed Chair Powell noted he drives past a “substantial tent city” on his way to work. We hear from those on the ground in D.C. that some of these tents may have been there for years. But the image shows where policymakers’ focus is. Policymakers remain fixated on unemployment & underemployment (U6) and are willing to let the economy run hot (ie, the dual mandate is not balanced at the moment). The more 0.3% (or higher) readings we see on the core CPI index, however, the harder this posture will be to maintain.
In the meantime, expect to hear the word “transitory” a lot. As we’ve noted previously, the FOMC minutes for Mar 16-17 stated that “the 12‑month changes in total and core PCE prices were expected to transitorily move above 2 percent in coming months, as the low inflation readings from the spring of last year dropped out of the calculation window. In addition, inflation was forecast to be temporarily boosted this year by the expected emergence of some production bottlenecks and supply constraints. Following the transitory increase this year, inflation was projected to run a bit below 2 percent next year and then to reach 2 percent by 2023, reflecting tight resource utilization in product and labor markets.” This is a soft-landing Fed forecast.
Bottom line: If the Fed is going to miss on policy, they will likely be too easy vs. too tight (at least as long as Powell is in charge). The FOMC is still insisting underlying inflation dynamics are 1) slow moving, and 2) global in nature. In the meantime, factory production needs to ramp up further.
Source: Strategas
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by FactSet.
Sincerely,
Fortem Financial
(760) 206-8500
team@fortemfin.com
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