The recent inflation data included the first time a month’s core PPI was flat and core CPI was negative. Service industry inflation has peaked and the upward trend in rents has been broken. Core CPI for goods deflated YoY for each month over the past 12 months, which is unusual. It hit a peak at 2.3% and didn’t beat the previous cycle high of 2.5%.
The core CPI (which excludes food and energy) is about 50% composed of rents. However, 65% of the population live in owner occupied homes, some with fixed rate loans or no loans. Those who rent often have a smaller residence as tenants, so the impact of rental inflation on them is not as big as if they were an owner since they have smaller residences. If 50% (times 65% who are homeowners) of core CPI is based on imputed owner-occupied housing costs that are hypothetical but not actually being paid, that is huge distortion in measuring inflation. That’s 32% of core CPI are imputed rent for owner-occupants who don’t actually pay rent.
Another core cost is medical care. But this cost is modest for those under age 50, compared to what a 55 year old pays for health insurance. For those who have reached age 65 they get low cost Medicare. Thus health care inflation mainly hits those age 50-64 and mainly affects those who lack employment with a lucrative high wage and benefit employer who pays for a full service policy.
Assuming no tariff barriers are erected I expect more desperate cost cutting moves by the EU, Japan, China, EM countries, and now the UK, to export low cost things to us in a bid to create jobs for their citizens. I expect the dollar will go up more thus lowering the costs of imports. Domestic manufacturers will have to cut costs to match the importers. Thus there will be more deflation from goods producers.
Domestic energy fracking continues to be done with ability to obtain dramatically lower breakeven costs. Thus the OPEC countries won’t be able to disrupt our cheap oil and thus oil will continue to be available at low, stable prices. This helps with creating low expectations of inflation.
The sluggish economy grew at 1.7% a year since the top of 2007. This is only 0.7% a year better than the Great Depression despite huge stimulus available now. Growth below 2% is below stall speed so soon the economy will go into a recession. Typically when employment reaches around 4.5% the economy has reached its peak and begins to decelerate. We are now at 4.5% unemployment.
Economists have estimated the “natural rate” of interest where everything is in equilibrium, should be about 0.25% for short term fed Funds, which implies the 10 year Treasury should be a bit under 2%. If a recession breaks out then the 10 year Treasury Note will retouch the lows of July, 2016 when it hit 1.37%.
Investors need independent financial advice about the risk of being fooled by fear of inflation into avoiding bonds when now is a good time to buy bonds. Avoid excessive duration risk. Avoid junk bonds. Avoid stocks because their PE10 ratio is almost double that of fair value.