Good morning. Tuesday’s US consumer price inflation report was surprisingly benign (see below), but markets did not celebrate. Perhaps the good news was offset by higher oil prices (see below, again). But then, one day’s trading always means less than you think. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.
Chill(er) inflation is nice
The inflation climbdown starts now. That was the Wall Street consensus after yesterday’s cooler US CPI print, and I’ve no reason to doubt it. Core inflation (that is, excluding food and energy) rose an annualised 4 per cent in March, or 0.3 per cent from February, lower than the 0.5 per cent the market expected. One reason was the long-awaited deflation in used cars:
Forecasters see headline inflation, which hit 8.5 per cent in March compared with a year ago, gliding down in the next few months. Here’s Deutsche Bank’s outlook, as good a stand-in for the consensus as any:
There are two reasons for this expectation. First, price increases in crucial areas have stopped accelerating. Shelter inflation, for instance, grew at the same seasonally adjusted pace as last month, a hint that the worst is over. Services ticked up to 0.6 per cent from 0.5 per cent, but was accompanied by minus 0.5 per cent durable goods deflation — in line with the widely predicted post-pandemic rotation from goods to services.
Second, base effects are kicking in. That is, big price increases a year ago mean even bigger ones are needed now to sustain 7-8 per cent year-on-year inflation. The March numbers suggest that bigger increases aren’t coming.
It was just enough good news for the market to briefly gasp for breath. The 10-year/2-year yield curve spread steepened 9 basis points. Stocks rallied briefly before closing slightly down; oil cresting above $100 a barrel was the supposed explanation.
The news was good — but only relative to expectations. The Ukraine commodities shock was unmissable in the red-hot headline number. Headline and core inflation diverged the most in 17 years after energy shot up 11 per cent in March alone. Within the core measure, shelter inflation, as Unhedged has noted, is likely to stick, and 7 per cent annualised is a mighty uncomfortable level to stick at.
There is, in other words, more than enough to worry about, notwithstanding yesterday’s sprinkle of optimism. The Federal Reserve looks ready to shrink its balance sheet and raise interest rates in bounds, not steps. But the central bank has to keep its eyes on the data. It won’t want to tighten into an economic slowdown that is happening anyway, and there are hints that it might be.
The withering rise in mortgage rates — nearing 5 per cent nationally — is the growth headwind we’ve been watching most closely. Fiscal policy is another. The Brookings Institution estimates the first-quarter fiscal drag on growth at minus 2.1 percentage points. BlackRock’s Rick Rieder points out that inflation itself is a damper on growth. Food, energy and shelter — some of the fastest-inflating categories — make up 62 per cent of total consumption. More money spent on essentials means less for everything else.
But we’ll take the good news. Inflation that falls a little faster than expected, if the trend continues, will make the Fed pulling off a soft landing a touch more likely. It’s nice, even if we are not anywhere close to out of the woods. (Ethan Wu)
Martijn Rats on oil
About a month ago, we spoke to perhaps the most prominent bear in the oil markets, Citi’s Ed Morse. He made the case for falling oil prices, based on the following premises:
Current high demand is evidence of a recovery, not secular strength in the economy.
The war in Russia is unlikely to disrupt supply as much as the markets expect.
US shale fields are going to produce more than the market expects.
Producers around the world are responding to higher prices with expanded production.
Yesterday I had a conversation with Martijn Rats of Morgan Stanley, who takes a much more bullish view on the oil price. He thinks the transition to solar will take longer than many expect, and that oil demand, correspondingly, is set to stay strong for a while. He made several points investors with energy exposure will want to keep in mind.
The oil market is not sending clear price signals right now. “The volatility has been hard to stomach,” Rats said, and has driven financial speculators and traders out of the market, in flight from prohibitively high hedging and margin costs. This is a bad thing. “Speculators provide risk capacity to the market — they absorb risk from the market, for a fee. They take a view on price and value, rather than being pure sellers [like oil producers] or pure buyers [like, for example, airlines].” Without them, the market struggles to settle on a price range.
$100 oil is not expensive enough to destroy demand. “All the product markets — diesel, gasoline — are very tight. That does not say demand destruction. That says people are willing to pay.” Rats also pointed out that $100 oil implies that about 3-4 per cent of gross domestic product would be spent on energy, a historically normal or even slightly low level.
The oil price may not be pricing in the impact of lower Russian oil exports, even without European sanctions on oil. “There is an idea out there that only Europe is not buying Urals [oil piped from Russia]. But look at Espo [Eastern Siberia to Pacific] prices — they are at a big discount to Dubai [the Asian regional benchmark], too.” That discount, on oil piped east from Russia, is bigger than weak demand due to the Chinese shutdowns can explain, Rats said. “This suggests the Chinese refineries are also not that keen on the Russian crude.”
He estimates that the logistical frictions involved in shifting Russian exports from Europe to markets that are keen, such as India, will cost Russia perhaps 1mn barrels a day of exports, out of a total of 7mn-8mn.
He is surprised that market consensus expects a much larger slump in Russian exports, even without direct sanctions — about 3mn barrels a day. “The market has not priced 3mn barrels in,” he said, noting that a 1mn barrel disruption in supply from Libya in 2011 was enough to move the market by $30 a barrel.
If sanctions are added on top of the frictional declines? The price impact would be difficult to estimate, he said. But very big.
One good read
We’re late to this, but the FT’s John Thornhill wrote an excellent piece on what he learned running a start-up.
Source: Economy - ft.com
