There is a battle between long-term (secular) disinflation and a short-term cyclical rise in industrial-based inflation
The market is desperately hoping the cyclical inflation wins, and it still has the edge for now, but not this month
1/
⚠️ Warning ⚠️
In the next few months, the base effect will boost inflation big time and it will be consistent with the cyclical upturn in inflation, but the CPI growth will fade after the easiest comp.
That aside...
2/
Headline CPI edged slightly higher in year over year growth rate terms but remains stubbornly low, and way too low based on breakeven rates.
Core inflation has rolled over, declining to 1.4% year over year. The secular disinflationary trend is very hard to battle.
4/
One of the key disinflationary forces is the major decline in rent inflation resulting from damage to our cities. This is one part of the story that most are missing. The gains in home prices & demand-pull-forward are coming at the cost of cities, not increases from new income 5/
Commodity based inflation is rising, reaching 1.4% year over year.
This is known ahead of the report.
6/
🚨Durable goods based inflation ticked lower to 3.5% year over year. This is bad for the reflationary narrative as durable goods and the industrial process are the driving force behind the reflation.
We are seeing inflation pressure in the early part of the supply chain but due to weak consumers (labor market), some of the price increases that are passed on to the end consumer are slowing down.
8/
A rise in producer-based inflation but a decline in consumer-based inflation means there is a lack of pricing power which is consistent with weak economic conditions. For now, one month doesn't make a trend but this is a key area to watch.
9/
Services based inflation continues to tumble, falling to 1.3% year over year as the loss of income, social distance rules and change in consumer behavior badly impacts the service sector.
10/
Even excluding rent, services inflation is still declining, falling to 1.0% year over year.
11/
The relative ratio between goods inflation and services inflation is subsiding.
Way, way too early to declare the cyclical upturn in inflation "over."
All economic indicators still support a cyclical increase in inflation for the next few months.
12/
We simply may be witnessing a softening in the ability to carry over pricing power from producers to consumers once the bulk to the stimulus fades and we have to start consuming from a weakened level of earned (wage) income.
More to come on this story.
(end)
13/13
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While the DKW model is imperfect, it provides some context around which factors are driving Treasury rates higher.
The DKW model was recently updated for EoM January.
(Thread)
1/
To start, as I have commented many times in the past, the economy is in a clear cyclical upturn, so we should expect the vector or direction in both growth expectations and inflation expectations to move higher.
2/
However, embedded within a 10-year rate is 10-year assumptions, not easily moved like Y/Y CPI or growth. These are long-term, slow-moving averages.
3/
Headline inflation ticked up slightly and is mostly a balancing act between rising goods inflation and falling services inflation.
2/
Goods inflation continues to rise, jumping to nearly 4% on a year over year basis.
Goods inflation (and industrial commodities) are rising due to manufacturing backlogs caused by shutdowns and the overall shift to at-home goods consumption and away from services consumption.
This is because of a sudden & forced shift to at home goods consumption that caught everyone offsides
The restocking upturn is set to continue
Once the industrial upturn runs it's course, we'll be back to the same old trends
1/
There's been a secular trend of services consumption growing faster than goods consumption.
2/
That trend shifted suddenly but is unlikely to last for years after the economy re-opens. This shift is likely temporary and a result of forced lockdowns, fear of consumer-facing businesses, etc.
Long-term expectations do not change as frequently as daily market fluctuations would make it seem.
A quick update on Treasury rates through the lens of the DKW model
*As of Dec. 31*
1/
In previous threads, I made the distinction between long-term secular trends in growth and inflation and shorter-term (2-6 quarters) trends in nGDP growth
Right now, the long-term trends are unaltered because long-term trends just don't change that fast but we have a very strong cyclical upturn in the economy, centered primarily on the shift to goods consumption bolstering the manufacturing sector and industrial commodities.