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CPI warns of strong inflation but Treasury yields fall

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The Consumer Price index (CPI) for May climbed to 4.99% (YoY change), while core CPI (excluding food and energy) jumped to 3.80%.

CPI & Core CPI

Part of the annual change may be due to base effects but monthly percentage change of 0.80% (CPI) and 0.74% (core CPI) convert to annualized rates of 9.60% and 8.88% respectively.

CPI & Core CPI

Measured over two years, the compound annual growth rate (CAGR) of CPI is only 2.5% but sharp acceleration in recent months warns of stronger inflation ahead. Hourly wages growth of 4.6% CAGR over the last two years is our expected target for CPI.

CPI & Core CPI

10-Year Treasury yields ignored the high inflation numbers, falling to 1.444% in after-hours trading. Breach of support at 1.50% (and subsequent respect) warns of a correction to test support at 1.0%.

10-Year Treasury Yield

Conclusion

Strong annual CPI growth is partly due to base effects, from low readings in May 2020, but the sharp acceleration in recent months is a warning that the Fed should not ignore. The fall in long-term Treasury yields is not a sign that inflation expectations are easing but rather that price signals are broken. The Fed is purchasing $80 billion per month of Treasuries (and a further $40 bn of MBS) to support demand, while Treasury has slowed issuance by running down its $1.6 trillion general account (TGA) at the Fed. Between the two, they can set prices wherever they please.

We expect strong inflation, with a target of 4.60% p.a., and real interest rates deeply negative as the Fed and Treasury do their best to suppress bond yields. We are therefore underweight bonds and growth equities and overweight precious metals and commodities.

Quote for the Week

The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.

~ John Maynard Keynes

Disclaimer

Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.

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