Just as folks were talking of a “soft landing” when there has been “no landing”, now the discussion is about the “last mile” in the inflation battle…right when the latest CPI print indicates that the journey toward disinflation may be more of a marathon than a sprint.
Whether the most recent CPI number will prove to be an aberration, or perhaps just a seasonal anomaly, remains to be seen. However, on the surface the number was objectively bad. Some of the highlights (lowlights for those long duration) included: The Cleveland Fed’s CPI was +.5% vs. +.4% in December; The all-important ”Supercore” measure of services, excluding shelter, rose (important as the Fed seemingly fixates on this number); and The Atlanta Fed’s sticky price inflation indicator also turned higher.
We highlighted in a recent commentary how past inflationary periods have proven that inflation tends to cycle before ultimately becoming dormant. Assuming this most recent print turns into a trend and inflation is indeed cycling higher (i.e. higher lows and higher highs), will the markets be caught off guard? It would appear that the very non-zero probability that inflation remains entrenched is not being priced in at all, as evidenced by the associated Fed Reserve Policy probability chart.
While most Central Banks are contemplating the beginning of an easing cycle, New Zealand’s Reserve Bank is still deciding whether to raise rates at its next two meetings in February and April. One may question the validity of comparing the rate policy of such a minor economic player to the rest of the world, however the Bank of New Zealand has consistently been one of the most disciplined and measured Central Banks over the last 20 years, and their behavior has tended to lead the Fed in this most recent tightening cycle.
Takeaways: Despite the fact that inflationary periods very rarely end with a smooth and linear downward arc, markets appear to be overwhelmingly pricing in exactly such a scenario. This misplaced narrative, combined with another burgeoning debt supply picture, leaves interest rates highly susceptible to a major upside shock.