The government reported the inflation numbers for March, and investors got the numbers they wanted to hear.
The CPI increased 0.1% month over month with an expectation of 0.2%. Core CPI came in at 0.4%, the same as expected. The reaction to the news was relatively swift. The price of gold rose $24 (to $2041), and crude oil rose $0.90 (to $82.40). The S&P500 front month futures jumped $32 (to 4,140), and the yield on 10-year US Treasury bonds fell by 6 (to 3.36%) basis points. The yield to maturity on 2 US Treasuries fell a much larger 0.14 (to 3.92%). Bitcoin has risen about 80% this year but did not react much. It is up just $100 (to $30,260)
Investors think price inflation numbers like this suggest the Fed may raise interest rates for the last time in three weeks.
The exhibit above shows the Fed will raise rates by 0.25% in 3 weeks, hold rates steady at the June meeting then start a series of rate cuts starting in September. By September 2024, investors are betting the Fed Funds rate will be cut in half to 2.75 to 3.00%. Time will tell if investors’ expectations are correct.
We are not so sure. A review of the 1970s suggests that inflation is stickier than mainstream economists expect. This causes the Fed to be less hawkish. This allows the inflation genie to continue to cause problems for longer. We would point to the federal government’s budget numbers. The deficit for March (to be announced at 2:00 today) is expected to be $318 billion. This compares to just $193 billion in March of last year.
The budget deficit has improved from the C19 low, but it appears the improvement has ended. When the government repeatedly passes legislation to spend $1 to 2 trillion, it is hard to see how the situation might improve.
Issuing government debt is inflationary as it adds to the broader M2 money supply. People who own US Treasuries can borrow and spend against those holding, so they act as high-power money with a twist. They get into trouble if there is a sizable move in interest rates. Signature Banks and Silicon Valley Bank found the vulnerability of owning bonds, thinking their value was as stable as cash.
The final issue we would like to address is the profitability of the Federal Reserve system. The Fed usually makes tons of money because it issues cash, buys bonds, and earns interest. Its biggest expense is the interest it pays on deposits, primarily from commercial banks. The Fed is now paying out $40 billion monthly more in interest than it collects on its bond portfolio. So the Fed is essentially bankrupt. However, they cannot go bankrupt because they can print money to pay interest. Alternatively, the Treasury can cover their losses. This has never happened before, so the long-term effect is uncertain. But if the past is prolog, then it will be solved with money printing which is inflationary. This is one of many reasons why we think the inflation genie is not dead.
We plan to watch the markets today before suggesting a trade suggestion.
