Summary
Inflation Misconceptions and Lagging Metrics: The narrative of resurgent inflation is overstated, driven by seasonal factors and lagging imputed metrics in inflation measures like CPI Shelter. Leading indicators and fundamentals suggest inflation remains within historical norms, and concerns about persistent inflation are misplaced (for now).
Market Behavior and Rate Expectations: Aggressive market behavior in equities (e.g., record buying at the ask) reflects sentiment-driven trading, not economic fundamentals. Rate cut expectations have decreased, but seasonality and fundamentals indicate inflationary pressures will abate, likely reviving rate cut conversations in 2025.
Top Comment
Several have asked about my views on Russell Napier’s hypothesis of “financial repression” — basically that governments will artificially suppress interest rates while allowing inflation to destroy the real value of excess government debt.
I want to be clear, I have always thought this would be a temptation, but also believed it would be devilishly harder than Russell indicated. I found it particularly silly to be focused on this idea when western central bankers trotted out their “inner Volcker’s in reaction to the inflation surprises of 2021-2022 and hiked rates aggressively. Russell seems to have come around to my point of view. In a recent podcast, he noted that he now saw risks of deflation as higher than inflation, while retaining his long-term view of financial repression:
MWG Response:
This fully squares Russell’s view and my view. The inflationary response is coming, just as it did for COVID, but FIRST comes the credit event. As discussed in today’s note, the simple reality is that deflation, not inflation, remains the risk. And as hypothesized last summer, Powell may have taken the bait.
The Main Event
Way back on September 1, 2024, I shared a concern:
My analysis suggests Powell has created a trap for himself—cutting interest rates modestly from these levels will not help the indebted and will harm the wealthy. A seasonal resurgence of inflation (which has HELPED the transitory case over the summer, but will reverse into Q4) will lead him to be less aggressive in cutting rates, further increasing the risks of the “phase change” of credit defaults. Once the indebted default, they become economic pariahs for the proverbial “seven lean years.”
And true to form, that seasonality differential has contributed to the conclusion that inflation is resurgent:
And now the market has priced virtually zero cuts for Fed policy (h/t @dampedspring):
And this despite the reality that “transitory” remains the correct, if unpopular, conclusion. With the exception of an 18-month stretch capturing the post-pandemic policy response (and supply shortages) and the Russian invasion of Ukraine, absolute levels of inflation have been restrained. Perhaps not as low as post-GFC, but honestly, the difference between 1.9% and 2.6% is statistically insignificant, and that is WITH the lagging impacts of imputed services, as Powell (and now Waller) are highlighting. If we replace CPI Shelter with either New Tenant Rent or Zillow, that 2.6% falls to roughly 1.8% and it was transitory indeed:
LEADING indicators of inflation, for example pricing plans for Small Business per the NFIB are running BELOW the levels of 2023, suggesting that while the deflationary pricing pressures are abating, fears of resurgent inflation are misplaced:
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