Fed: U.S. Economy Still "A Ways Off"

Let’s not get too excited. Whenever Powell delivers dovish signals, as yesterday, the cheers often turn into jeers over the medium term.

Rinse, Repeat

With Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), telling Congress on Jul. 14 that the U.S. economy is “still a ways off,” investors rejoiced as the rhetoric implies that tapering is “still a ways off.” However, while Powell repeated his classic lines and maintained his classic stance, his short-term suppression of U.S. Treasury yields and the USD Index will likely result in even more violent upswings over the medium term.

Case in point: while Powell painted an ominous portrait of the U.S. economy, the Fed also released its Beige Book on Jul. 14. For context, the report consolidates data from 12 regional Fed banks ranging from the New York Fed to the San Francisco Fed.

Excerpts from the report read:

“The U.S. economy strengthened further from late May to early July, displaying moderate to robust growth. Sectors reporting above-average growth included transportation, travel and tourism, manufacturing, and nonfinancial services. Energy markets improved slightly, and agriculture had mixed results.”

“Healthy labor demand was broad-based but was seen as strongest for low-skilled positions. Wages increased at a moderate pace on average, and low-wage workers enjoyed above-average pay increase... All Districts noted an increased use of non-wage cash incentives to attract and retain workers.”

More importantly, though:

Source: U.S. Fed

What’s more, the NFIB Small Business Optimism Index (released on Jul. 13) increased by 2.9 points in June (to 102.5) and rose above 100 for the first time since November 2020. For context, the Fed’s latest Small Business Credit Survey (SBCS) included the following tidbit: “The SBCS is an annual survey of firms with fewer than 500 employees. These types of firms represent 99.7% of all employer establishments in the United States.” The bottom line? The behavior of U.S. small businesses has a profound impact on the U.S. economy.

The NFIB report revealed:

“The net percent of owners raising average selling prices increased seven points to a net 47% (seasonally adjusted), the highest reading since January 1981.”

“A net 39% (seasonally adjusted) reported raising compensation, a record high. A net 26% plan to raise compensation in the next three months.”

“Owners’ plans to fill open positions continue, with a seasonally adjusted net 28 percent planning to create new jobs in the next three months, up 1 point from May. Job creation plans remain at record high levels.”

Quite the contradiction from Powell’s assessment, huh?

Source: NFIB

Moreover, while Powell’s dovish comments uplifted the PMs on Jul. 14, the NFIB’s commentary included an ominous warning:

Source: NFIB

On top of that, I’ve been warning that rent inflation could add further upward pressure to the Consumer Price Index (CPI) in the coming months. And on Jul. 7, RealPage – a technology platform that serves over 19 million rental units worldwide – revealed that “rents are climbing at the fastest pace seen in decades.”

Please see below:

 Furthermore, if we isolate the large U.S. areas with “at least 100,000 apartment units,” the situation is even worse: ranging from 10% year-over-year (YoY) growth in Orlando, Florida to 19.2% YoY growth in Phoenix, Arizona, the Fed is sitting on an inflationary time bomb.

Please see below:

In addition, while Powell cites “base effects” as the reasons for the inflationary surge, new rental agreements are already tracking ahead of their pre-pandemic counterparts. And with the Shelter CPI accounting for more than 30% of the movement of the headline CPI, used cars and trucks should be the least of Powell’s concerns.

But even more revealing, the commodity PPI surged by 19.51% YoY on Jul. 14 – the highest YoY percentage increase since 1974. For context, the commodity PPI has increased by 15% or more YoY six times since 1994. And with 330 monthly observations recorded over that span, it amounts to 1.8% of historical readings. Furthermore, with the commodity PPI also rising by 1.83% month-over-month (MoM), Powell will likely regret his patience over the medium term.

To explain, I wrote on Jun. 15:

The commodity PPI often leads the headline CPI and that’s why tracking its movement is so important. If we analyze the performance of the pair during the inflationary surges of the 1970s and the early 1980s, it’s clear that the relationship has stood the test of time.

Please see below:

To explain, the green line above tracks the year-over-year (YoY) percentage change in the commodity PPI, while the red line above tracks the YoY percentage change in the headline CPI. If you analyze the relationship, you can see that the pair have a close connection.

More importantly, though, during the historical inflationary downpour, the month-over-month (MoM) percentage change in the commodity PPI never declined by more than 1.68%.

Please see below:

To explain, the green line above tracks the MoM percentage change in the commodity PPI. And if you compare the two MoM spikes in the commodity PPI to the two YoY spikes in the first chart above (focus your attention on the highs between 1972-1975 and 1978-1981), you can see that MoM resiliency helped sustain the YoY surges. In addition,, during the roughly nine-year bout of inflation, the commodity PPI dipped in-and-out of negative territory but never fell off of a cliff.

Now, if we circle back to the present, the YoY increase in the commodity PPI implies a headline CPI print of roughly 5.15% to 5.65% in July (when the data is released in August).

Please see below:

Finally, BlackRock CEO Larry Fink – who heads the world’s largest asset manager – told CNBC on Jul. 14 that “I worry about inflation [and] I do not believe inflation is going to be transitory.”

“I’m not trying to suggest that it’s going to be a straight-line upward, and there could be disappointments going forward. But overall, with the amount of fiscal stimulus and monetary stimulus, and more importantly with the amount of cash that is looking to be put to work, I believe the trend line is still going to be upward.”

More importantly, though, when speaking with Reuters on Jul. 14, he also predicted the following:

Source: Reuters

In conclusion, while the PMs applauded Powell’s performance on Jul. 14, history has shown that the cheers often turn into jeers over the medium term. For example, nearly every dovish speech from Powell results in ‘PMs up, USD Index down.’ However, once the short-term high wears off and reality returns, the reversal of fortunes often ushers the precious metals lower than they were initially. Moreover, while taunting inflation may seem amusing in the short run, the Fed’s nonchalance will likely result in an even faster taper once the pressure mounts. And with gold’s largest 2021 daily loss more than 1.58x its largest daily gain, the precious metals will likely run for cover once the drama unfolds.

Moreover, let’s keep in mind that gold stocks didn’t “buy” yesterday’s strength in gold. Their exceptional underperformance continues to suggest that the medium-term trend is down and that what we saw recently is nothing more than a prolonged breather before another downswing.