The August CPI report was a shocker in that the expectation was for inflation to finally drift lower. In fact, the report confirmed that inflation continues to run at an elevated pace and the Fed’s raising of short-term interest rates is doing little to quell the uptick. To put it into perspective, the year-over-year rate of inflation last August was an already an elevated 5.25%. At the time, the Federal Reserve wrongly assured investors that inflation was transitory, and they didn’t need to adjust monetary policy because in short order the uptick would pass. Recall, at the time Chairman Powell was up for renomination and, we suspect, reluctant to do anything to battle rising prices, fearing that to do so would torpedo his chances for renomination. From our perspective, he had done a lousy job and should not have been renominated, but that did not come to pass.

As expected, the Consumer Price Index (CPI) in June registered the highest inflation in 40 years. Year-over-year the rate of price appreciation of the CPI came in at 9.1%. In reviewing the details of the report, the source of the inflation is broad-based. Even more troubling, recent surveys indicate that consumer expectations for future inflation are climbing.

Earlier this month the jobless report showed that the economy added 372,000 new jobs in June, well ahead of the 265,000 that was expected. Given the anecdotal weakness we’ve been witnessing, our expectation was that the jobs figure would disappoint. Contradicting the headline number, the household survey showed a decline in the labor force of 353,000 jobs. As we’ve explained previously, the two measures are usually directionally in agreement, but not always.

Last week investors were delighted that the Fed only raised interest rates 50 basis points and Fed Chairman Powell drove home the point that a 75 basis point hike was not forthcoming. However, by the next morning, the relief had been replaced by anxiety that stagflation is on its way, stock prices are too high and the yield curve too flat. Since the announcement, the S&P 500 has tumbled sharply, joining bonds in the year-to-date bear market. The current long bond (2 ¼ % 2/15/2052) is trading at a price of about 82, down from its issue price of 100 in February. At a dollar price of 82, the yield-to-maturity calculates to 3.20%, offering a real interest rate (Treasury rate – inflation rate) of about -5.00%. Moreover, with the latest selloff, the 2-year/30-year yield curve has steepened approximately 45 basis points since April 1st. Typically, the yield curve steepens when market participants believe the Fed is losing the inflation battle.

The February 24 invasion of Ukraine by Russia has resulted in heightened volatility as bid/ask spreads have widened and liquidity has dried up. President Biden’s decision to punish Russia’s aggression by halting purchases of Russian fossil fuel has caused the price of a barrel of crude oil sky-rocket. West Texas Intermediate briefly touched $130 a barrel on March 7th before settling in around $106 a barrel at the time of this writing. The rise in oil is having a direct impact, as one would expect, on gas prices. While the general population is aware of the dislocations in the capital markets, the rise in the price of gasoline is a direct hit to their wallet and one that has the average citizen worried. Economic forecasters are attempting to back into the price of a gallon of gasoline should the Russian oil ban become a sustained policy, and their forecasts are frightening. Estimates are as high as $150 to $200 per barrel of oil with gasoline topping out at $8 to $10 per gallon. Should the price of a gallon of gas rise to that level, we’re fairly confident that the U.S. economy will be in a recession. As it is, the Atlanta Federal Reserve’s GDP calculator is forecasting 0.041% economic growth in Q1 2022. We wonder how the investing public is going to react to 0% economic growth after enjoying 6 quarters of “eye-popping” economic growth fueled by emergency COVID stimulus. The first estimate of that growth comes at the end of April so we have plenty to worry about between now and then.

For the second month in a row the non-farm payroll and the household employment reports have diverged. The establishment survey came in at less than half of consensus expectation at 199,000 new jobs, while the household measure registered 651,000 new jobs for the month. That measure was enough to push the unemployment rate down to 3.9%, and just above the post-financial crisis low of 3.5%. That comes on the back of the surprisingly hawkish minutes of the December 15th FOMC meeting. Not only did the minutes solidly indicate a March rise in Fed Funds, the committee apparently had a meaningful discussion on the appropriate size of the Fed balance sheet under normal circumstances. That discussion included how fast they would allow a runoff of maturing securities. The minutes failed to detail a targeted amount, but it’s certainly well below the current balance of $8.2 trillion. They did indicate that a “substantial buffer” is the likely target. Also, some participants favor a complete runoff of the Fed’s mortgage-backed holdings in favor of Treasury debt. That last point could become problematic in a rising rate environment. Mortgage-backed securities are negatively convex, which is to say that as interest rates rise the duration extends. In a rising interest rate environment home owners are less likely to refinance and the pace of maturing MBS would slow, perhaps materially.