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Inflation? We’ll See

Tomorrow we have the official inflation gauge released by the federal government.

Of course we can choose to believe or not believe whatever the number is that is released in the CPI report–I choose to not believe it–BUT I care how markets react to the number.

The estimate on the consumer price index is up .3% which would be a slight increase from last months .2%. Core inflation is estimated at .1%, again up slightly from the 0 last month (core inflation removes food and energy from the calculation).

I have no idea where the numbers will fall and I don’t think equity markets will give a rip–if the number is ‘hot’ analysts will say the increase is ‘transitory’ (moving from a recession to growth). The economy remains awash in liquidity and markets will probably move higher for the foreseeable future.

Interest rates markets will be a bit more cautious. Interest rates keep trying to move higher, but haven’t gotten over the 1.19% hump yet–the 10 year treasury closed at about 1.16% today. I am looking at March, 18th last year where rates popped to 1.27% which is the highest close in the last year, after dropping sharply from 1.90% at the end of 2019. So I would not be surprised to see the 10 year move into the 1.20’s%.

Does it matter if the 10 year moves higher? Almost always the move will be tolerated if it is slow. For instance if we see a move to say 1.25% in a day and then a back and fill direction–no big deal–I don’t think income issues would flinch. If rates go from 1.16% to 1.30% in a day there will be some pain in the quality issues (i.e. low coupon).

Of course I will not react to any movement—you can’t react to 1 piece of data. It is almost always a losing proposition to try to move around your positions based on a couple pieces of data–save your energy and sit back and watch.

28 thoughts on “Inflation? We’ll See”

  1. The numbers just reported by the BLS (Bureau of Labor Statistics) say Food has gone up 3.8% last year and Energy has gone down 3.6%. I find the Energy number very hard to believe. Certainly not at the consumer level do they seem lower. During the early days of the Covid crisis fuel prices plummeted when no one was driving anywhere, but they seem as high or higher now than they were a year ago. Food at the retail level also seems higher. It is a little hard for me to compare as I moved across country this past year, but prices certainly seem to be going up for e from insurance, utilities, restaurants, etc, etc. 1.4% Overall? I don’t believe that represents reality.

    1. Try buying a TV, computer or similar electronics. The laptop I bought one year ago is up 50% in price.

  2. The Government issued inflation numbers are crap. If you want to look at a better proxy, especially as it comes to imported goods, follow the $ index.

    It’s off 12.4% from a year ago. That means that the US$, relative to a basket of major currencies, has declined in value 12.4%. This is the result of the Fed’s Magic Money Tree. The MMT advocates would have you believe that the U.S. can print money at will with no impact. That’s bull. With the next round of “stimulus” creating another 2 trillion of magic money it’s reasonable to think the US$ will drop more.

    This drop in the US$ will find its way into prices. Some sooner than others but it will come. Look at the things you buy that come from overseas and look at the comparative prices from a year ago. There has been an enormous increase in the price of imported good. It will take longer to show in domestic goods and services but it will come.

    1. Well, the economists in Japan might have a different take on it….
      They are exhibit A in MMT theory in actual practice by a country with a reserve currency.
      The Fed buying treasuries and mortgage backs at a record clip is what is getting my hackles up.

  3. I’m thinking floating preferreds like Goldman’s gs-a and US Bancorp’s usb-h are a fairly safe place to stash cash. They can be bought close to par, pay about 4% at today’s rock bottom interest rates, and will float up with any rate increases. Wondering what others think.

    1. Josh, Im not saying they are bad, but optimally the best time to buy low end floaters is when the long end starts pulling away further from short end and market notices it. See right now the minimum yield floaters are competitive with fixed perpetuals.
      But if your base assumption is long end moving higher, you wait for the ramifications to hit the perpetuals as their yields readjust higher. At that point the minimum rate floaters “cant compete” and usually drop in price. That is when you get your bang. But of course that has to happen first, which that may not occur. 2013 was a good example. 10 year raced off to 3%, fixed perpetuals dropped hard, and these minimum floaters dropped hard also because libor was still going nowhere at the time while long end was off to the races. What we really need is a floater adjusted to the 30 year bond. But market isnt stupid and isnt attaching a long duration adjustment to a long duration perpetual. That benefits the preferred holder and they sure dont want that to happen.

      1. Gridbird…you should have been (maybe were?) an engineer. I had many clients who were engineers. They would understand your explanation. Most others would just have a blank stare.

        1. Retired, Ha, any decent national engineers association would have you thrown into the stockades for such an accusation! I slid through college in early ‘80s when only a course in bone head math was needed to graduate. No calculators were needed in class provided you were born with the full accompaniment of finger and toe digits to do work the computations. 🙂

      2. Thanks gridbird. The distinction between the long and short end of the curve, instead of simply “rising rates” is something I hadn’t considered (although it seems so obvious now). I’ve opened a position in both of those names but will watch the long end of the curve before adding. Much appreciated.

        1. Josh, Nothing is a certainty as you know. Predicting interest rate movements is a fools hobby. Now one can invest to cover their rear a bit based on comfort levels, but thats about it. Just look at how quickly passengers ran from the “negative interest rate” side of the ship to the “long end is headed higher” side of the ship. Meanwhile as we make projections, the market is just gonna do what its gonna do.

      3. Floater adjusted to the 30-year bond? Like Buddy Holly said, “That’ll Be the day”.

        The closet you can come is a 10-year reset, and those are few and far between. HBAN, SCHD and TFC each offer one.

        1. Hmm- don’t see any. And SCHD? a Dow index based?
          There is TEMP08 with a 5yr.
          I must be missing something- thx

          1. I would take it all day long. SCE must have been hard up to offer such sweet terms.

            1.45% plus the highest of the three-month LIBOR Rate, the 10-year Treasury CMT and the 30-year Treasury CMT.

            1. Bob, For duration protection, isnt that a sweet set up? But I think Buddy Holly will perform live again, before we see one of those again.

    2. Josh – the weakness in the argument is that you can get considerable inflation without commensurate interest rate increase, especially on the short end. The Fed controls the short end. if they want zero it’s zero. The Fed has less control over the long end but then they can manipulate that, too, a la Operation Twist of some years ago.

      What the Fed can’t control however is exchange rates. Those will be market set for the most part.

      As well as considering adjustable rate issues think about assets that appreciate because of inflation, whether the Fed has admitted inflation of not. It’s the usual cast of characters.

      1. With that same point in mind, Bob I recently doubled an investment in RALOX
        Lazard Real Assets & Pricing Opportunities Fund…. it’s not the best way to play this theorem, in fact it’s not even well rated by Morningstar but it’s at least a lazy man’s way of participating…. Any other ideas of a set it and forget it way to position oneself?

        1. I’m not sure how to play the hypothesis. But I looked at RALOX. According to Morningstar, it badly trails both the category and the index.

          1. Like I said, ain’t the greatest, but one of the easiest ways to find a fund focused theoretically on a broad basket of hard assets. I do have a longtime respect for Lazard as a firm though…

        2. I recently bought Horizon Kinetics Inflation Beneficiaries ETF, INFL as a way to play this game.

    3. The problem with USB-H is that the floating rate on that preferred is based on the greater of 3.5% or 3-month LIBOR + 60 basis points.

      With LIBOR at 20 basis points today, let me quote one of my favorite songs from 1980s band Foreigner:

      “You are a long, long, way from home.”

      But it sure would have been nice to buy USB-H during the March 2020 carpet-bombing when it traded down to $15.

  4. Does it matter ? we’ll see. but it does have us looking Tim and talking about it.
    Which funds would benefit from movements in rates?

  5. In other signs of the bizarreness of this market, the Bloomberg Barclays U.S. Corporate High-Yield index fell to 3.96% today, which must be some kind of record.
    This is one of the most widely tracked junk bond indexes. With the risk of junk bonds, 4% is insanely low reward for that kind of risk except in times of deflation.

    1. Justin said: “Bloomberg Barclays U.S. Corporate High-Yield index fell to 3.96% today.”

      If we assume the market is correct on pricing these junk bonds, it means one of two things for our ~5% preferreds

      1) They are even junkier than we think


      2) Investment banks/companies have them under-priced aka over couponed, which means new issue rates will continue to fall, and the callapalooza will continue. . .

      1. Its hard to tell without more info on whats in the index, as BB+ is high yield junk. So it depends on credit mix, cap structure (ie, how much is senior secured, senior unsecured), and obviously duration. But that being said, quality perpetuals today are not compressed yield wise compared to corporate debt.
        The current spread between yield and 10 year bond is still historically good. So its not the spread compression lowering preferreds as much as its just the low yield environment. So yes there is possible scenarios for lower issued preferreds. But chasing that thesis could be even more painful capital wise on interest rate spikes.

    2. As a point of reference: I hold 2 junk bond funds. (wouldn’t think of going there with individual issues) Fidelity (SPHIX) paying 4.25% and Vanguard (VWEHX) paying 4.34% .

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