| July 21, 2023

Maybe inflation is tamed and maybe interest rates will fall soon. That better happen for the traders who are excited about the latest inflation report. I am not so sure. For those who may have missed it, the Consumer Price Index (CPI) for June came in at 3% over 12 months and 0.2% for the month.* Many traders view 3% as close enough to the Fed’s 2% goal to declare victory. A closer inspection of the Bureau of Labor Statistics (BLS) website tells a more nuanced tale.

When we look at all items less food and energy, inflation for the past twelve months has continued at 4.8%. The big 12-month inflationary declines are in energy and energy-related goods and services. Fuel oil has dropped by -36.6% and gasoline has declined by -26.5%. Unsurprisingly, airline fares have fallen by -18.9%. On the other hand, food at home increased by 5.7% and services sans energy went up by 6.2%.

Commodities other than food and energy only increased by 1.3%. I believe that much or most of the behavior in commodities and energy is due to the failed China recovery. The narrative that China would reopen and drive global growth has not materialized. In energy and commodities, we are seeing demand-side deflation. Even the Saudis are having a tough time holding the line on prices.

Low energy prices are a good thing for consumers and businesses. They operate as a kind of stimulus that increases discretionary spending and is a relief for working families. Hooray for that. Unfortunately, the underlying cause is a disappointing global economic backdrop. Core inflation is still too high, and we may only be seeing a temporary reprieve on the inflationary front. Meanwhile, the Federal Reserve continues to suck cash out of the economy by allowing their bonds and mortgages to mature. I see the current appetite for risk as likely to continue until reality sets in.

We are entering what I see as a risky period and do not expect the attainment of the Fed’s 2% inflation goal without a recession. We are certainly closer to the end than the beginning of rate hikes, but the continued reduction in the Fed’s balance sheet and global economic weakness is likely to lead to further monetary deterioration before we move into a new cycle.

Maybe I am wrong about this and maybe this time is different. If so, no harm done, we are invested after all. If I am right, we will be glad to have big allocations to relatively high-paying and liquid T-bills and T-notes.

* Consumer Price Index - June 2023 (