The Labor Department reported the CPI this morning. Our view going into this, which we shared here and on Twitter @mguthner @the_OptionsEdge, was that (1) investors are optimistic about the number because gasoline prices are down. (2) the market is likely to have a big reaction because people will either love or hate it, and (3) it is likely to be hotter than expected.
We were very nervous about our third prognostication because we were leaning against the crowd and the crowd was very loud.
The table above shows the consensus view and the actual numbers. People thought CPI would drop slightly in August, but it rose a bit instead. Year over year, CPI is at 8.3%, and we continue to believe that it will be 8% or higher for the intermediate term. Quantitative tightening has not started yet, so we see no reason for inflation to come down. As we mentioned in our video on inflation, the quantity of high-powered money increased by a factor of 6 relative to the size of the economy. This means there is plenty of inflationary fuel in the tank to push prices higher. Reducing the money supply is what it will take to bring inflation down. Giving up the money printing addiction will be just as painful as giving up any other addiction.
The stock market is down hard in the premarket, and the 10-year bond price is also down (yield is up). Investors will have to come to terms with the persistence of inflation and incorporate that into their interest rate, profit forecasts, and valuation calculation.
Tomorrow, the government will announce the Producer Producer Inflation measure. We suspect it will be bad as well. We might sound imbalanced in our view, but we recognized that gasoline prices were down, and that would bring down CPI. But we experienced significant food inflation in August, and the media seemed to ignore that.
We now expected wages to rise. Yesterday, it was announced that the folks working the railroads received a 14% raise in past inflation, and their contract gives them another 10 percent spread out over the next few years. This is a tentative agreement with a few more unions to go. We think this kind of agreement is what we are likely to see over the next few years.
We think the Fed will take this all in as they figure out their next move. Investors are now pricing a 14% chance of a 100 basis point increase in short-term rates. A 50 basis point increase is now off the table. If tomorrow’s PPI number is hot, that probability will surely rise.
We plan on sitting on our hands at the moment as we want to see tomorrow’s PPI number before suggesting any trades. We hope our readers have followed our lead by derisking their portfolios by holding some cash and hedging with bearish options trades on IWM of SPY options.
