We get inflation data this week: PPI on Tuesday and CPI on Wednesday. As energy prices and yields soar, we continue to see steep discounting across retailers and autos while housing prices, and commercial real estate fall – inflation in all the wrong places and deflation in all the same places. Meanwhile, the S&P 500, despite being 40% off its highs has seen a remarkable 3 month 40% rally. The market appears to be pricing in the Goldilocks of all Goldilocks economies: not too hot and not too cold, but “juuuust right”. Owners of stocks are essentially betting that inflation won’t run wild and deflation will loosen its death grip on the assets that we own. Investors are betting that the Fed will thread the needle between inflation and deflation perfectly.
This week PPI and CPI are expected to jump from recent readings. PPI is expected to come in at 0.7% after a 0.3% reading in April. CPI is expected to come in at 0.3% after a 0.0% reading in April. It will be very interesting to see how the market responds to this data. A lower than expected reading could lead investors to believe that deflation is a greater threat than previously believed, i.e., the Fed’s reflation trade isn’t working as well as investors might think. A higher reading than expected could lead investors to believe that inflation is getting a bit ahead of the Fed and higher interest rates are in the cards.
I believe the likelihood of the Fed threading the needle is extraordinarily low. If there is anything we have learned from this crisis, it is that the Fed’s interest rate policy has been far from proactive and arguably destructive. The Fed has pumped so much cash into the system that it will be incredibly difficult to turn off the liquidity spigot once it gets started.
Unfortunately, we’re not seeing a spike in inflation because the velocity of money remains low. Consumers are still in a deflationary spiral due to massive debt levels so lending has yet to pick up. If the U.S. consumer were to rebound sharply the likelihood of runaway inflation would be unavoidable. Until then, I continue to think that consumer balance sheets will normalize and the threat of deflation will remain.
The odds of a Goldilocks scenario are very low. Instead, this looks more like a “damned if we do (print money), damned if we don’t (print money)” scenario. Will this be the week where the market begins to realize this?