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Weekly Points – June 14th, 2024 – 5 Things to Know in Investing This Week – The Fed Has No Idea What It’s Doing Issue

I wish I were making this up, but Jerome Powell actually acknowledged the Fed doesn’t have high confidence in its own forecasts. In fairness, we don’t have confidence in their forecasts either. DKI pointed that out in a recent monthly letter where we detailed how inaccurate even near-term Fed forecasts have been. Past that, there was a lot of news on inflation and rates. The CPI came in light, but the Fed dot plot is MORE hawkish. Confusing? Don’t worry:  We’ll explain. We’ll also dive in to the contentious issues surrounding why Americans aren’t more excited by the great economy our press keeps extolling. Finally, there are some good questions about the Petrodollar on the table. I’ll take on that complicated issue and reference Running on Empty, the fantastic book by Alexander Macris @archon , which explains the history and the collapsing future of selling oil exclusively in dollars.

This week, we’ll address the following topics:

  • The CPI comes in light – doves rejoice.
  • The Fed raises and tightens the dot plot – hawks rejoice.
  • The Fed acknowledges a lack of confidence in their own projections. DKI agrees.
  • Inflation “down”. People unhappy. We explain.
  • If the Petrodollar falls, what happens to Japan and the price of oil?

Ready for a new week of admittedly bad forecasting? Let’s dive in:

1) The CPI Comes in Light:

The May Consumer Price Index (CPI) came in at 3.3% which was 0.1% below both expectations and last month’s mark. Of greater significance, the Core CPI, which excludes food and energy, was up 3.4%, also 0.1% below estimates. The sticky Core number has continued to decline. The all-items CPI benefitted from lower energy prices and was hurt by continued high shelter prices.

CPI - June '24

The sticky Core CPI is getting better, but now the all-items is sticky and above where it was a year ago.

CPI - Absolute Values - June, 2024

Prices constantly rising. This is why Americans aren’t excited by disinflation.

DKI Takeaway: The market got excited by the 0.1% “beat”, but I don’t think the Bureau of Labor Statistics is capable of measuring anything to within a tenth of a percentage point of accuracy. I continue to believe food inflation is undercounted, and note that the price of used cars is coming down from pandemic-era highs. Inflation has come down (disinflation), but remains too high. The second chart shows how inflationary changes compound over time. That means that even if inflation goes to zero, Americans will still be paying much more for necessities than they did a few years ago. Finally, there were an unusual number of reports exclaiming that if you excluded a bunch of items, inflation is actually zero. I’m not a fan of the methodology of excluding the rising prices of things people need to buy in order to conclude high inflation is actually no inflation.

2) The Fed Raises and Tightens the Dot Plot:

The Federal Reserve concluded its June meeting and kept the fed funds rate unchanged. Given some of the weak economic news from last week and the lower-than-expected CPI, there were some who were betting on a Fed rate cut at this meeting, but most were unsurprised by the continued pause. The commentary in the press release was intentionally clear and reiterated that the goal remains getting inflation down to 2%. It added that “the Committee remains highly attentive to inflation risks”.

Federal Reserve Dot Plot

The dot plot got more hawkish.

DKI Takeaway: The market was looking at the dot plot for any changes. We started the year with expectations of six .25% rate cuts. At the April meeting, that was reduced to three cuts. Speculation was whether the Fed would lower to just one or two cuts at the June meeting. If you look at the chart above, the dot plot on the left is from April. The far left column shows expectations for the end of 2024 with two Governors expecting no change, two expecting one cut, five at two cuts, nine at three cuts, and one expecting four cuts (1.00%). The median was three cuts. The June meeting (image on the right) shows the range was raised and tightened with four Governors expecting no change, seven at one cut, and eight at two cuts. That leaves the new median at just one cut. In the fourth quarter of 2023, DKI told you the expectation for six cuts was unrealistic and said to expect “higher for longer”. That’s exactly where we are now.

3) The Fed Highlights its Lack of Confidence:

Following the conclusion of the Federal Reserve’s June meeting, Chairman Powell spoke with reporters. One asked about an anomaly in the Core PCE projections. Powell explained that comparisons in the second half were challenging and that’s why the Committee expected potentially higher PCE numbers later in the year. Then he added, “Now, do we have high confidence that that’s right? No.”. The Fed has more data than anyone else and an army of economists with PhDs. They control the most important metric in finance. And just told the world they don’t have confidence in their own projections.

2023 Fed Dot Plot Rate Estimates (1)

We agree with Powell. The Fed has no idea what it’s doing.

DKI Takeaway: Let’s at least give Chairman Powell credit for telling the truth. DKI subscribers did very well when we highlighted that inflation was a huge non-transitory problem in November of 2021 which contradicted Powell and Treasury Secretary Yellen, who both thought inflation was a minor short-term problem. In a monthly letter earlier this year, DKI pointed out that the Fed is terrible at predicting the fed funds rate, which it controls. Look at the 2023 chart showing the change in the Fed dot plot. Fed Governors also thought they’d have inflation under control and with lower interest rates. Reality was more challenging and reflected “higher for longer”. With the Fed aware of its failures in making predictions, we believe they’ll err on the side of higher rates until they’re certain they have inflation under control.

4) Inflation is Down – Why are People Unhappy:

I’ve lost count of the number of articles I’ve seen this year criticizing Americans for not being more grateful for our wonderful economy. The financial press seems very excited by disinflation which is a slowing of the rate of inflation. These financial cheerleaders appear to be forgetting that prices are up a huge amount in the past few years and that a slower rate of increase on an already high base isn’t relief for most people. As a reminder, inflation is hardest on lower income people who aren’t benefitting from high asset prices, but are getting crushed by constantly climbing prices.

Inflation Since 2020

This is why people are unenthusiastic about disinflation.

DKI Takeaway: Economists and the financial press are increasingly enamored with measures of inflation that exclude the things that most people need to purchase. The chart above shows where people tend to spend most of their money and I’m even skeptical of that. I think food prices are up more than 25% in the past few years and that anyone who thinks the cost of housing is up less than 25% hasn’t gone home shopping in a while. That shelter cost also excludes higher mortgage financing costs with mortgage rates more than double the 2021 lows. Even some smaller items are causing problems with car insurance up 20.3% in the past year. I suppose if we exclude food and energy and ignore the run up in housing prices, it’s possible to conclude that inflation isn’t a problem. If you’re a real person trying sitting at the kitchen table paying your bills, you won’t be able to exclude those items.

5) With the Petrodollar Falling, What Happens to the Price of Oil:

The best work I’ve seen on the history and future of the petrodollar was done by Alex Macris @archon. He turned his four part series on the subject into a fantastic book called “Running on Empty”. Alex was kind enough to ask me to write the foreword to the book where he correctly predicted that the Saudis would start to accept currencies other than the dollar in exchange for oil. That has happened, and this week, I saw a question regarding the impact of the decline of the petrodollar on oil prices and Japan.

Running on Empty Cover

I’ve read this three times if you want to know what I think.

DKI Takeaway: My prediction is that even as the Saudis accept other currencies in exchange for oil, crude will continue to be priced in dollars. If the dollar price of oil is $80 per barrel, the price in other currencies will most often reflect that dollar price and a current exchange rate. Forward contracts will likely reflect the dollar price, a current exchange rate, and the forward pricing curve. Should foreign demand for the dollar decrease over time, those excess dollars will come back to the US looking for things to buy leading to higher prices. Another way of saying this is we’ll see reduced purchasing power of the dollar. That leads to more inflation here in the US. In Japan, they’d likely see higher dollar prices for oil, but similar yen prices as a weaker dollar comparatively strengthens the yen. This will take years to play out fully so expect more coverage of this issue in the future.

Here’s the video version:

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