US macro/inflation

US CPI was out overnight, and the reason for the market selling off today.

0.4% MoM for core was “a bit hot”, and it pushes out the timing and quantum of cuts, a touch.

Worth keeping in mind that January can be a little messy, difficult to read given many prices reset in January for the year ahead, & as such might be masking the improving underlying trend.

Equally, macro data has generally been stronger, lately (PMI’s stabilizing, confidence lifting, GDP and retail sales remaining strong) and both the Fed and the market are reprising upwards their estimate of “just how high” rates can go before they cause activity to roll over.

That measure of “just how high” is the natural rate, r*, and, in the back of our mind, is the subject of almost every note we write.

There’s also the issue of rents, which we’ve written about many times. We expect inflation to come down, because of lagged measures of owner’s equivalent rent. Current rents tell us OER’s impact is overstated, which would mean lower future inflation prints as the current rents wash through.

It would (should) look something like the below, as it plays out over time…

…but instead we are getting this, a divergence.

If you link it back to the concepts of goods, services and shelter, you can see the above graph’s blue line, looking much like the below graph’s light pink bar plot.

And so, for now, the market prices out rate cuts, and pushes back on their timing.

We think they’ll come, and expect 3% in time as more likely for the 10 year, than we do 5%. And that buying treasury bonds with a 4% handle usually works out pretty well, even if means a somewhat bumpy ride in the interim.

That said, we sold a little bit of our credit exposures, recently, predicated on the idea that credit spreads had narrowed to unsustainably low (or at least unrewardingly low) levels, and that will have proved a useful trade.

If we are to be in a somewhat rangebound bond market, for a little while, modest trading at the margin, around that longer run view that north of 4% is excellent portfolio ballast should work out well.

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