Once again, the news was almost uniformly bad; once again, equity markets reacted as if each piece of bad news just brings closer the days of good news. Bonds also suffered yesterday, for a change, but that is more likely related to the inflation data.
I shouldn’t get ahead of myself. Our first ouch was provided yesterday morning by UBS. For the love of Pete, when will these banks learn to supervise traders? UBS announced a $2bln loss stemming from “unauthorized trades” in the equity unit. Seriously, how hard is it? Someone needs to be sending collateral around – is it so difficult to get the collateral management system to talk to the risk management system? Granted, it’s very difficult to catch a determined rogue trader from causing damage in a short period of time – real-time surveillance isn’t possible when markets require real-time reactions. But these losses – yesterday’s announced $2bln loss, the $7.2bln that Kerviel lost for Soc Gen, and others we have heard about and smaller ones we have not – generally occurred over a period of time, exploiting a loophole in the system.
This is another argument for smaller financial institutions. Forget “Too Big To Fail;” what about “Too Big To Supervise”?
After the UBS announcement the economic data ouches started to roll in. Initial Claims rose to a 2-month high at 428k, and is essentially unchanged from a year ago. Empire Manufacturing, expected to be -4.0, was actually -8.82. Philly Fed was -17.5 versus -15.0. And of course, there was CPI.
The consensus for core inflation was for a ‘soft’ 0.2%; instead, we very almost saw another 0.3% print. Year-on-year flashed 2.0% (although it was actually 1.951%). These sound like small details, but the internals of the number were strong. For starters, core inflation ex-housing is at 2.2% and a bit ahead of pace to reach the 3% by year-end that I first mentioned in this July comment. So, while core CPI is approaching 2.0%, remember that it is being restrained by housing.
Having said that, it isn’t being restrained that much anymore, although I think there’s another down-leg to housing prices now that foreclosures are picking up again. The following table shows the year-on-year change by major subgroup in the CPI. Housing is now back to 1.6%. Along with Apparel, Food & Beverages, Recreation, and Education/Communication, the y/y pace of change quickened in August. That’s ¾ of the whole CPI, and the balance is either unchanged or showing marginal declines in the case of Transportation.
|Weights||y/y change||prev y/y change||Year ago y/y change|
|All items|| |
|Food and beverages|| |
|Medical care|| |
|Education and communication|| |
|Other goods and services|| |
This breadth of advance is one reason that the CPI figures are starting to get scary. I pointed out last month that the Cleveland Fed Median CPI is no longer giving reason, as it did throughout 2010, to think that core CPI still has a lot of catching up to do. The Median CPI printed 2.0% this month, just what core CPI did.
I think what is also underappreciated is that while the level of inflation isn’t worrisome yet, the acceleration is. Core inflation, and median inflation, are by design very stable. They’re supposed to capture just the important moves. The chart below (click to enlarge) shows that the Cleveland Fed Median CPI hasn’t accelerated by more than 1% in a year since 1984, and only decelerated faster than that in the recession of the early 1990s and in the credit crunch when the velocity of money plunged. In short, median CPI is pretty stable. The picture for Core CPI looks similar.
It is in that context that we might look with some alarm at the 1.5% acceleration in median CPI (and 1.1% in core CPI). Not only is it already quite unusual, it is almost guaranteed to get worse in the next couple of months (since the bottom in CPI was in October 2010). Note, by the way, that the acceleration in 1984 occurred in the context of much higher core numbers, so a 2% acceleration was less impressive than it would be today.
Now, a fellow inflation trader pointed out that previous spikes in the acceleration were always in the past followed fairly quickly by an outright drop in inflation. The difference, though, is that in those cases the spike precipitated Fed action to restrain inflation. The Fed was tightening in 1988, in 2000, and in 2004. That is why inflation decelerated, not because of any natural cycle. The difference is obvious – in this cycle, the Fed is aggressively easing. I trust I don’t need to connect the dots any further than that!
In case it helps, though, I will note that with the release of yesterday’s M2, the 13-week rate of change is now over 24% (annualized), the 26-week rate of change is up to 14.7%, and the 52-week rate of change is 10.55%. And I will also point out that yesterday the SNB, BOE, ECB, Fed, and BOJ jointly announced the provision of dollar liquidity arrangements to banks that need it. (Seems it was only a day or two ago we were told no banks needed it!)
And that, perhaps, is the biggest ouch of all. The inflation data, and not the growth data, was the reason that 10-year rates rose 10bps yesterday. Half of that came from breakevens, and inflation swaps at the short end of the curve were even more well-bid. TIPS continue to sport extraordinarily-low yields, but we are seeing why.
Housekeeping note: This is the last commentary I will be writing for a couple of weeks. My family and I are traipsing off to New Zealand on a vacation and to watch some World Cup rugby (Go Eagles!). My next post will be circa October 4th. Good luck in the meantime, and good trading.