The release of the August CPI on Tuesday morning caught stock market bulls way offsides when inflation numbers showed that prices rose in the month of August. This should put the peak inflation narrative to bed as prices still remain stubbornly high across the board in the economy, despite falling gas prices taking place in every week in the month of August. In fact, across the nation gas prices at the pump have now dropped for 7 straight weeks, yet inflation remains high across all other sectors of the economy. Here are the numbers:
***CPI m/m 0.1% vs. -0.1% expected
***Core CPI m/m 0.6% vs. 0.3% expected
***Prices remain 8.3% higher this August vs. last August
***Despite a 10.6% drop in gasoline prices, the month still showed an increase in the inflation rate
***Biggest increases were seen in food, shelter & medical services
***CPI is up 5.3% in 2022 (on pace for annualized rate of 7.95%)
***Core CPI is up 4.2% in 2022 (on pace for annualized rate of 6.3%)
As mentioned yesterday prior to the CPI data release, the overwhelming majority consensus on the Street was that inflation had already peaked and that the CPI would decline for the month of August. Everyone was in the risk trade, buying the ARKK stocks and the NASDAQ along with the QQQs going into the print with this mentality. After the release, traders needed to get back onside, which led to a major stock market route intra-day. I’m writing this at 12:00 PM EST Tuesday, and here is where we stand across the major averages:
Of course, we now have much more of a reversal to start pricing in here on risk assets in general. The ARKK fund, which is currently down 6.5% intra-day, is still up 7.5% on the week. I expect this fund, along with a lot of non-profitable growth stocks to start making new monthly lows here in the next few weeks.
I can increase my confidence in being short the ARKK fund based on the bond market’s reaction to the CPI release today as well. Upon release, bonds immediately sold off sharply as the 10-year reached 3.433%, making a new high in yields on this move, and the TLT continues to get absolutely clobbered. Down another 1% on intra-day lows, the long term government bond fund TLT is now down 8% on the month and 26% YTD. This fund has not fallen quite nearly enough, but the reaction in bonds this morning is quite telling - bond traders are now starting to price in longer term inflation expectations slightly. Of course the bond market still has a ways to go before it correctly prices in longer term inflation as much as it is needed, but investors are showing no willingness to jump into bonds here on a flight to safety as risk assets get clobbered. Investors are starting to recognize the risks inherent in bonds as the Fed becomes a bigger seller of bonds into the open market. As this action in the bond market continues over the course of the next several weeks, interest rates are going to surge even higher, putting more downward pressure on an already fragile US stock market as growth stocks will keep getting hammered.
Moving to commodities, gold traders are sticking to the trading playbook that has been used over the last 2 years. Higher inflation data > Fed will fight inflation > interest rates will rise > sell gold. The rise in bond yields hurt gold’s appeal this morning as the yellow metal sold off $30 immediately after the CPI data release. Interestingly enough, we are seeing some buyers come in a buy the dip in gold, and gold has recovered about $10 off the lows. This shows me that some investors are starting to recognize that inflation is in fact starting to become embedded in the economy, and that we have a long road ahead before inflation even begins to calm down.
Oil also surrendered its overnight gains on the inflation news, likely due to the same action occurring in gold. However, oil continues to hold steady at $86 per barrel, and gas prices are likely going to stop declining sooner rather than later. The inflation data was bad enough as it is, yet the overall percentage of inflation was helped drastically by falling oil prices in August. If oil can make it back above $90 per barrel, there will be a lot more pain regarding future inflation. By the way, this is the continued depletion of the US strategic petroleum reserve:
This has helped cap oil prices throughout the tail end of the summer, but we are running the oil spigots dry and soon dried up supply will catapult oil to fresh highs.
Another big piece of the inflation data was fertilizer prices, which continue to rise almost daily. This is putting continued pressure on agricultural prices, which will lead to higher grocery store prices in future months. With the nation running low on energy supplies all over, we are heading into the winter months as ill-prepared as we could possibly be for the cold winter month’s ahead.
We also saw an increase in rent prices in the CPI. Just as wages are sticky inflation, so are rents. Rent prices, once risen, never go back down. But here is an angle of inflation that I personally hadn’t even considered prior to seeing this thread on Twitter:
This makes total sense, and brings out an interesting point. Sure, higher interest rates is what is necessary to bring down inflation in the long term. But in the short term, rising interest rates will actually put more upward pressure on the CPI. Not only is this going to be impactful in rent prices, but also in business costs. Corporations and small businesses have record debt levels, and as interest rates rise so will the cost of capital and doing business. Those costs will also get passed onto consumers who continue to not be stripped of endless sums of credit to pay higher prices, and we see that inflation, as bad as it is, is about to spiral even further out of control.
Here is the last point I want to cover on the market’s reaction to inflation today:
As you can see my views closely align with Peter Schiff’s take on gold prices, but look more closely at the second part of the thread. For 2 years now, every time inflation data is released and comes in higher than expected, traders have used the playbook mentioned above - higher inflation > Fed will fight harder to stop inflation > sell gold & buy dollars. But the point above shows the incredible ignorance being showed by market participants. I could have understood that being the reaction to higher data when everyone was spreading the ‘inflation is transitory’ narrative. But now that those spreading that false claim have been proven absurdly wrong, why are traders continuing to follow the same playbook? Its as if everyone has complete faith and confidence in a Federal Reserve that has gotten everything in the past two years completely wrong. It also shows that investors today are not brushing up on their history. I’ve made this point before, but for those who have missed it -
***INFLATION HAS NEVER GONE ABOVE 5%, THEN CORRESPONDINGLY COME BACK DOWN TO 2% OR LESS WITHOUT OVERNIGHT LENDING RATES (CURRENTLY 2.5%) GOING HIGHER THAN THE RATE OF INFLATION DURING THE SAME GIVEN TIME PERIOD IN THE HISTORY OF FINANCIAL MARKETS ACROSS THE GLOBAL ECONOMY!!!
If inflation continues to be well over 8% officially, and 20% unofficially without the government rigging the numbers, why is every investor and their mother expecting that a 3 or 4% Fed Funds Rate is going to break the back of what has proven to be consistently high inflation across every spectrum of the entire economy. The reality is, everyone on Wall Street remains completely clueless. Which is why commodities, especially gold & oil & the stocks in those sectors remain at incredible buying opportunities, along with many value-oriented stocks that have the pricing power necessary to pass higher prices onto their customers.
One other reason for why gold may be continuing to follow the same trading playbook is trading algorithms, which are a big driver for markets in today’s world, especially in FX. However, as the playbook on the gold trade gets re-written in the near future as traders recognize how bad the inflation problem is going to be in the longer-term future, those algorithms may get re-wired as well. Traders will also need to recognize that at some point since inflation is not coming down in the next several years, rising nominal rates are not bearish for gold because REAL interest rates are still not rising. Think of it this way - inflation rose by 0.1% in August. That would represent a 1.2% annualized increase in consumer prices if we extrapolate that out for 12 months. Last month, the Federal Reserve raised interest rates by 0.75%. So in essence, nominal rates in August rose by 0.75%, but in real terms interest rates fell by 0.25%. So interest rates can’t be a threat to gold unless they get to a REAL positive level. As mentioned above, we are not even remotely close to that whatsoever.
Since I am releasing this edit today, I will skip tomorrow’s edit and be back on Thursday. I am going to pitch Nutrien as a buy in that edit.
Best
Ryan Garzone
True North Market Research
truenorthinternationalpartners@gmail.com