Taps Coogan – May 17th, 2021

David Rosenberg of Rosenberg Research recently spoke with CNBC about last week’s ‘hot’ inflation print to explain why he still thinks rising inflation and bond yields will prove temporary.

Mr. Rosenberg has been in the deflationary camp of the inflation vs. deflation debate for years. As the interview above attests to, he clearly hasn’t changed his mind and argues that only a few categories of goods, like used cars and reopening sectors, were responsible for the “skewed” read in inflation.

“The market is having difficulty differentiating between what is true lasting inflation and what is price level adjustment. So, when you actually go beneath the headlines you’re going to find that most of the inflation what in a few areas like used cars… you also have 10% increases or thereabouts in hotels and accommodations and in sporting events and things and of that nature which you’d be expecting with the economy reopening… The Cleveland Fed actually publishes a median CPI and this shows your the distortion. Headline was up 0.8 but the median was up only 0.2. So, it was a very skewed report.”

However, in seeming conflict with his dismissal of rising inflation as being skewed by just a few categories, he warns that if this pace of inflation keeps up for even just one more month, the Fed will have to react:

“Look, if we get another number like this next month, the Fed is clearly going to have to start changing it’s tone and I’ll be compelled to change my forecast…”

There was little excuse for being surprised by the high inflation number in April. All of the leading factors correlated to inflation were pointing to inflation in excess of 3% April CPI, as we noted repeatedly in April, March, and February (here, here. here, here, etc…). Used car prices started surging nearly a year ago and never stopped. The “base effect” argument is largely irrelevant for a handful of reasons including that no major inflation measure went negative year-over-year in 2020. 

It should be no surprise when the May inflation number comes in ‘hot’ too, though apparently it will be for some. Inflation measures like CPI lag actual price increases and food, car, housing, leisure, etc… prices are still accelerating. The economic reopening isn’t even finished. 

A highly indebted and over financialized economy with slowing demographics and an inability to execute pro-growth economic reform is vulnerable to deflation. It’s not a coincidence that the inflation of the 1970s corresponded to the low point in Post-War debt-to-GDP and the high point in the pace of growth in the labor force. Today we are in the opposite position.

The Fed knows this, or at least knows enough to worry about deflation, and is thus focused on trying to get inflation. Due to changes in fiscal and monetary policy since Covid, as well as the nature of this recession, they are going to be much more successful at getting inflation than they were after the Global Financial Crisis. We are already seeing that.

We are likely to get surprisingly strong inflation right up to the moment that the Fed starts to worry about inflation. That inflation, even if it’s transitory, will last longer than one month. Let’s see where things settle out later this summer.

Once the Fed starts really worrying about inflation, we’ll be left with an overindebted economy, stagnant workforce, no appetite for pro-growth reform, and tightening monetary conditions. Every single recession and multi-year bear market since World War II has been preceded by the Fed tightening against the backdrop of rising inflation.

The Fed seems to also have learned that lesson too, hence they are promising to completely ignore inflation and not even think about thinking about raising rates. Of course, that will simply cause inflation to overshoot more quickly (as it already has), making it harder for them to ignore inflation and raising the stakes when they eventually change their tune.

It’s impossible to know where that doom loop ultimately ends up, but the Goldilocks zone for markets that dominated the post-Financial Crisis landscape was created specifically by the failure of the Fed’s policy to produce inflation (as the Fed measures it). That is not the case anymore. We’re charting new waters.