June 2019 – Monthly Commentary

June 2019

Last month we discussed the sudden and dramatic shift in interest rate expectations given the weakness of the May jobs report.  We wrote about how that was not the first undershoot this year and that previous misses have been reversed in subsequent releases.  It turns out that our guess was right, as the June jobs report, which was expected to show 160,000 net new jobs was actually reported as a gain of 224,000.  Anticipating that it would be more than enough to convince the Fed not to raise rates, investors dumped fixed income, causing the yield-to-maturity of the 30-year to jump by nearly 10 basis points by the end of the day, as traders looked forward to Fed Chairman Powell’s testimony before congress the following week.  The expectation was that he’d focus on the unexpectedly strong report and walk back the notion that the Open Market Committee would need to reduce rates at the end of July.  In doing so he would be able to regain some of the confidence lost this year and avoid exacerbating imbalances already evident in the capital markets.  Instead he went full-on “dovish,” denying that the current job market could be described as “hot,” and emphasized the global slowdown occurring outside of the United States.  On the day of his testimony to the Senate, the Bureau of Labor Statistics released the Consumer Price Index with the measure exceeding expectations.   The Core Index, which excludes food and energy, rose 2.1% year-over-year, above the Fed’s supposed target of 2.0%.  Equity investors were euphoric to have better than expected economic data and the Fed preparing to cut interest rates.  

We’ve noted on numerous occasions that the average American, when asked what they think their personal annual rate of inflation is, responds that it’s 3%, give or take a few basis points, followed by griping about the runaway cost of healthcare, insurance, and tuition.  And yet month after month the BLS reports inflation that is well below that anecdotal rate.  Of course the BLS “adjusts” the index in various ways to smooth out the variation and take into consideration the changing basket of goods and product substitution.  We’ve always been skeptical of the BLS number and for good reason.  Entitlement increases are based on the CPI numbers and the lower they are, the smaller the annual increase.  In an effort to square the circle between the official inflation measure and the anecdotal rate of inflation that consumers so often quote we looked to The Conference Board, a private entity not affiliated with the U.S. government.  The Conference Board, among other things, conducts a number of surveys of consumer behavior and attitudes which investors study in an effort to understand the health of the economy.  Consumer confidence is the report that gains the most attention, but we looked to one of the secondary reports and were surprised by the tale it told.  The report, Consumer Inflation Rate Expectation 12-months Hence, showed that since 2001, consumers have not once expected their cost of living in the coming 12 months to rise less than 4.0%.  Not once in 216 measurement periods; we’d call that statistically significant!  The respondents are the average Americans who base their cost of living projection on the cost of items they buy and not a basket of goods that the statisticians at the BLS massage to make it seem as inflation is not eroding the value of our paychecks. By the way, in the most recent survey the expected cost of living increase for the coming 12 months is 5.1%.  And yet when we put pen to paper this time next month the Fed Funds rate is likely to be 25 basis points lower than where it stands today.  There’s no wonder that Chairman Powell’s credibility has fallen so rapidly.

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