The monthly PCE inflation figures were released today. Rents, as measured, act to exaggerate reported inflation. My opinion is that inflation is about 0.25% lower than the PCE because of a problem calculating inflation. The most recent Dallas Fed Trimmed Mean PCE, which is for May, was released today. For the Core Trimmed Mean PCE the 6 months data annualized figure is 2.0%; assuming an adjustment was made regarding the error in housing shelter costs then this would be 1.75%.
During the last year of a business cycle inflation usually has a sudden spurt upwards which may provoke the Fed into tightening excessively, thus triggering a recession. Be prepared for the possibility of a spurt in inflation and interest rates followed by a sudden reversal. For example, in the 2008 cycle peak the price of oil was $80 at the start of 2008, then it hit $144 in July, 2008 and a half year later reached $35, a drop of 76%.
Measurement of unemployment is warped by a lower than normal Prime age group Labor Force Participation Rate of roughly 2.5% lower than the patterns established before the great 2008 crash. If this missing 2.5% of the workers were included in the unemployment rate then unemployment would be about 6% instead of 3.8%. The proof is that real wage increases have been about zero despite the fact that inflation has been increasing. If this was a proper, normal recovery then employers would have started a bidding war for employees, resulting in real wage gains of 2%.
The problem of hidden unemployment is probably in the segment that is the lowest quartile of skills. These people are so weak economically that they are unlikely to cause inflation if they suddenly got a minimum wage job. Instead of worrying about the lowest quartile of the labor market one should examine the risk of inflation that would occur if middle-skill workers earning close to the national average median real household income of $59,000 were to get a real raise. However, this segment of the working population is at the greatest risk of having their jobs shipped offshore where wages are significantly lower, sometimes even 90% lower. Thus this group will continue to experience downward pressure on their wages, thus suppressing inflation.
The risk of a trade war backfiring and resulting in recession is rising and becoming more credible. The momentum (momo) factor for stocks has been broken since the SP index hasn’t had a new high since January 26th. As investors begin to realize that speculative technical investing is not making them any money and actually losing money then they will reduce their holdings of stocks, making prices go down. A stock crash will reduce consumption and thus dampen inflation, further acting to drive people into bonds.
Today it is possible to get “A” quality Muni bonds yielding the taxable equivalent of mid 4’s (assuming a tax-free yield of 3%) for those in high tax brackets who buy Munis. Thus investors have an alternative to owning stocks yielding 2%, which has the risk of a steep 50% price decline if the PE10 theory is true.
Investors need independent financial advice about the risks of inflation and rising interest rates.