#1012 - Inflation Is Hot… Now What? | with George Goncalves

0:00In an era where AI, robotics, biotech and digital assets are reshaping our reality, staying ahead is not just an option, it's a necessity for investors and entrepreneurs. Investors who embrace the technological revolution will benefit from the evolving investment landscape. Understanding these shifts is crucial for reaping future rewards. Today, we're giving you access to a free Real Vision membership and access to one of our most popular videos with Real Vision co-founder and CEO Raoul Pal and David Matten, founder of New World Same Humans. This thrilling conversation between two experts is a deep dive into the profound technological shift that's begun and how it's transforming not just financial markets, but our entire way of life.

0:47Head to realvision.com slash exponential age. That's realvision.com slash exponential age to get free access today. today.

1:04Inflation's hot, now what? Hi, everyone. Welcome to the Real Vision Daily Briefing. I'm Maggie Lake. With me today is George Goncalves, head of macro strategy at MUFG. Hey, George, great to see you. Great to be on with you, Maggie, as always. So rough day in the markets, to say the least. Stocks sold off, bond yields jumped higher after that hotter than expected reading on the consumer price index. It wasn't that much above expectations, but it was enough. You know, kind of felt like the market was primed for that. Fed meetings from the March meeting, Fed minutes rather from the March meeting also showed that Fed members themselves are worried inflation isn't dropping down to their target rate.

1:44And then piling on all of that was a disappointing 10-year bond auction. So just all around, a lot of fodder for those who are prone to be concerned, I suppose. But what did you make of the data and what you saw in the inflation reading? Yeah, I mean, all those things really made for a rough day for macro-type traders that maybe they're at least not set up for that sort of outcome. The numbers, I think, weren't that off the mark. I mean, there's now an obsession with this category called the super core inflation because chair pal has kind of clued us into focusing on this new number yes and it was 0.4 and it was rounded up 0.4 on both headline and core cpi it wasn't really that far off the mark i mean i can go into the details if you want yeah but it really it speaks to the how much the markets are on edge like they're on edge and they were not set up for it obviously looking at the price action.

2:43We did have a rally in rates yesterday going into it. So the setup wasn't great. Yeah, that 10-year auction, it was really just a perfect storm for a negative backdrop for rates. Yeah, which it's interesting to say that people were going into it, not set up for it, because all people have been stressed about, and the market's really kind of been sideways heading into that. There was just so much conversation about inflation becoming a problem. But the question is, where is it? So one thing I think is interesting, and we had someone just mention in the chat, this is a sort of nothing burger. Energy inflation is actually falling significantly.

3:23So if we look under the hood, we know that in some areas, there is a concern about reinflation. But it's kind of like you can find your argument, which maybe is what the issue was heading into this, because some people look at other indicators, maybe ISM services prices, and say, well, listen, we think that, yes, they're high now, but they're turning. If we try to lean on those forward-looking indicators, what are they telling us? Is this temporary? Is this something more lasting? And are we in a reinflationary regime? How are you parsing through all that? I mean, I don't think we're in a reinflation regime.

3:59It's just that It's not linear. It bounces around a lot. And now we're getting the echo effect of some of these sub indices that didn't have a chance or or companies and firms like insurance that had really raised prices. You're getting this echo effect of now inflation feeding through these other categories in inflation. I mean, I mean, I know you have my chart book. We can maybe look at page three. Brian, if you want to pull it up and just look at, this comes down still to housing, the fact that it hasn't really turned the corner or shelter costs, I should say, and how it hasn't really helped out on the disinflationary pressures.

4:37But if you strip out housing, of course, this is when everyone starts to throw their hands up in the air and saying, you can't strip out everything because otherwise there's really no inflation. But if you look at less food, energy, and shelter, that blue line, it's been basically at the Fed's target on average, it's turning a little bit higher now. But that blue line in the CPI, less food energy shelter, is basically at their target. And it's going to be bumpy. And I think that there is a challenge when it comes to energy prices, if we were to see an escalation in the Middle East get worse and oil prices move higher, but even just naturally going into the driving season, and if gasoline prices start moving up.

5:16The problem at this stage of the cycle, though, is that given consumers are relatively stretched, at least the lower cohorts are. If you had to move higher in energy, it's going to actually destroy demand and actually really minimize discretionary spending, in my view. And that would also fix inflation too. So it's going to be bumpy and the market doesn't like it. Market wants a linear path to 2 % and everything lined up perfectly. It's not going to be like that. We've had high inflation, or not as high as what we went through, but this is not accelerating. This is just taking time to get to its equilibrium.

5:48That's an interesting take on it. What about some of those core readings? We have Christopher just dropping some info in the chat on that. That's been worrying people who are maybe inclined to think along the lines of what you just mentioned, that, listen, it's bumpy, it's not linear, but those core readings seem to be worrying people. Yeah, the super core, I mean, these are really unique, specialized categories. And I say this, you know, and I say this with all due respect. I mean, we were told to focus on jolts for forever by the Fed, and then they forgot about the jolts. And now we were focused on super core.

6:29I mean, if they stop focusing on super core and they go back to their knitting, which is just normal core PCE, you're basically heading towards that 2.5%, 3 % inflation at some point. So it really comes down to, I think, that they wanted to have a reason to keep raising rates and then keep rates higher for longer. The core on CPI is not what they track anyway. So there's a wedge between core CPI and PCE for various reasons. It's sticky. I get it. And it makes their job harder. At a minimum, today, lowered everyone's confidence level, including my own, by the way. We're all data dependent. Let's not kid ourselves.

7:09We're at this point now. We're all data dependent. That's right. And you have to be honest with yourself while it's going down. But it's still three and a half, not nine and a half. And this idea that we're going to go from three and a half back to like five or six, then that will just really hurt demand and actually slow down the economy. So, yeah, if inflation spirals from here and I'm wrong and the Fed stays on hold for longer, then that increases the chance of things breaking in CRE and housing market again. And credit will not be able to survive with rates this high. And that is the what now that we were referring to.

7:43And we'll get into that market reaction in just a bit. I want to ask you about payrolls, about employment. So the wage inflation part of this is such an important part because it is considered structural and sticky, hard to roll that back. We know energy goes up and down. We have a lag with shelter. But that wage inflation part traditionally is something that really concerns the Fed. What's your read on what's happening in the labor market? Because that's been a little murky to figure out, too. It's been murky. And also the Fed has now also clued us in to think about that they have a dual mandate and that they are now starting to become a balance of risks, equally concerned about what's truly happening in the labor market vis-a-vis inflation.

8:29This wage price spiral thing is a very 1970s concept. it's always, and it's part of the Phillips curve concerns. And they're always worried about that. You have really tight labor market. It's going to generate inflation and becomes this self-fulfilling prophecy. But you just, I mean, it's not, it's, it's still, I mean, you can't use the word transitory because then you're going to get chastised. But I mean, it's, it is very, you know, unique to what we've experienced. And if you look at the labor market, let's look at chart five, for example, in the deck, it's perplexing because we're getting these mixed reads.

9:01Again, this kind of divergence between what the actual NFP is telling us and what other measures are telling us. And then if you really go under the surface, you're noticing the part-time versus the full-time, which has been highly scrutinized and covered both on X and everywhere else. And I have my own versions of those charts. The truth is probably somewhere in the middle that we don't have as robust of a jobs market at this stage. And it's probably the best that we're going to see at this stage. And therefore, wage pressures from here, I don't see it. taken off from here. And if you go to the next slide on slide six and look at the actual full employment landscape between full-time work and part-time work, that bottom half of that chart, you're seeing a pretty decent divergence between full-time and part-time work.

9:47And people can say, oh, this is by design. People want to work less. And people would rather have full-time benefits and everything else. I don't buy that argument. And if you then move to the next slide on page seven, this is why perhaps this is why one of the biggest enigmas or anomalies, we have stock market at the highs, apparently full employment and everything's hunky dory. Why is consumer confidence still so low? Why has it been so low? And if you look at slide number seven, this is the annual growth of full-time employment, which turned negative in the last few months. And it has a very good correlation with consumer confidence.

10:24I mean, I think all this stuff makes very logical sense. If your outlook on life in the economy is that you have full-time employment and you can maintain your bills, you don't have to take on three jobs to survive, I think then your confidence goes up. And on top of that, we had a big inflation scare, which still haunts most U.S. households. And they're like, look, we have high inflation, and I'm worried about the jobs outlook. Maybe this is as good as it gets. And stocks are at the highest, but I can't consume stocks. I have to actually have a paycheck. Hey, everyone. We're going to take a quick break right now to hear a word from our partners.

10:56We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

11:26Plus 500 gives you access to a wide range of instruments, S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, Forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus 500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus.

12:04Yeah. Yeah. And by the way, you know, if you're not employed and you mentioned that really important benefit component, if you're not employed, guess what? You're not participating in 401, too. So you've got to, you know, fund your own, which is a lot. I'm not going to say it's harder, but there's a there's a jump then. And when you're doing that and you're having to put out health care costs, the chance of you really contributing greatly to your 401k, this is a very American dynamic, but it's extremely important that you bring that up. And you're absolutely right. Faced with no benefit or retirement, that is extremely difficult for people.

12:38And I think there's a lot more worry about the future. You're essentially, even if you're making a higher salary living paycheck to paycheck, because you're concerned about covering an unexpected cost or having to cover a much higher costs for insurance and potentially 401 with no match than you would if you were part of a full-time situation. So I think that is, it's, we don't have, you know, it's harder to track, but you're right. I would understand why there's a correlation on that. What does that mean? How does that look? Does that move around or is that a consistent trend? That's where it's a little bit more difficult, but really, really great to raise that point.

13:14So what do you think this means for the Fed because they've got to be sitting there grappling with all of this too, since some of the models just don't work as well as they did before. Sure. Again, the key word that they've been telling us all along, they need greater confidence. And now this might be a setback. And it really then calls into question how you actually launch an easing or cut rates, because they're not going to want to claim that this is an easing cycle, because then the market's going to run to a whole level. Well, they caused that in the beginning. By the way, the reason everybody was anticipating that that linear drop in inflation is because they said they were going to ease.

13:51Yeah. Yeah. So there's a little bit circular logic here and arguments going on at the same time. But this is where this is why they have, you know, a, you know, multiple Fed speaker parades every so often because they're they're trying to calibrate the message and the message, you know, which we got from the minutes and we got a further read on it. You know, they're not ready yet to that kind of really moved down the road of cutting rates, but they know that rates are restrictive, but it's not working through the traditional channel. Like everyone says the U.S. is not rate sensitive. I was like, it is rate sensitive, but for different cohorts.

14:24And yeah, if you're locked in and you have a 3 % mortgage, good on you, but everyone else that didn't participate or is not now able to get into the housing market because affordability is the worst it's been and ever, like that really then changes the dynamic of the U.S. economy on a go forward basis. So rates do matter. They've now kind of like created what I call the have and have nots. Many others have used the same reference. And we have a bifurcated economy. We have an economy that is really geared towards those that have balance sheet and assets. And they're benefiting from that. And everyone else is really income dependent.

14:54And so then when you have to take on debt to like maintain your lifestyle or just maintain life, just like bare essentials, interest costs matter. And we're at this stage now where interest costs are really starting to hurt the lower. And I think that will end up with reduced consumer spending. And then, of course, Uncle Sam. I mean, U.S. government also is paying high interest costs, too. So rates matter. They're going through different interest rate channels, and it's taking longer to show up. That doesn't mean they won't. And that's why I feel like they should still ease. But getting like what went to ease is going to be so hard.

15:27I mean, I was in June. I mean, June, July. I mean, I think it still makes sense to ease. But if we keep getting readings like this, they're going to push it back. So I want to ask you about the bond market in just a moment. But you have a chart about that, the rate, because this rate impact, it's really interesting because the economy has been so strong. People are kind of like, oh, the economy can handle it. You know, it's fine. Other people we've had on are not as sure. They feel like that role is longer than maybe people thought. And yes, the 30-year mortgage is a different story. But even the haves have to have cars.

16:09You know, very few, you know, maybe everyone pays cash for them at a certain income level. But a bunch of people, even if they're in a really good mortgage, have to have cars. They potentially student loans. There are other credit card debt. There are other forms of debt that they're taking on. So how are we shaping up even if you take the mortgages out of it? Yeah, so I think if Brian looks at page eight and we pull it up and focus on it, and this is a chart from Bloomberg, and we looked at the mix between what the average household is spending as an interest cost, what's their budget towards interest expense on a running basis?

16:42I hate to use averages because, again, there's no average in the U.S. Some are able to afford things and some are really not. But on average, non-mortgage related interest is at the highest it's ever been. And it's nearly half of what a typical household is paying now between auto loans, credit cards, car loans, personal loans, you name it, buy now, pay later. I mean, so now interest will start to really matter for those. And some of those don't own homes either and they're renting. and so they're never going to be able to really participate in the housing side. So I think that rates matter. I think the Fed has to cut rates from what you can probably tell.

17:19And they have to steepen the curve and they have to make it more affordable for everybody else. But with inflation running the way it's been, it just pushes it back. And my concern is the more they push it back, they're going to have to either cut faster, but then they're going to be reacting to a slowing economy. And that will be really unfortunate. Yeah, and if we remember at the beginning with J-PAL, he was talking about getting ahead of that slowdown, trying to really engineer that soft landing and the lag. And we all talked about how different that approach was. But now, without the cooperation of inflation, perhaps that's off the table.

17:54So the market definitely changing its expectations today, reducing the possibility of a June rate, now putting the highest probability on something in September. We know this starts to get messy because traditionally the Fed doesn't like to do something right around election time. You've got that complication in as well. What is the bond market? Do you think that we saw yields go up? Do you think that we're headed back to 5 % on the 10-year? So, I mean, the 10-year got to some really critical levels today, like 455. We're at this upper channel. I mean, it should start consolidating here because if it doesn't, there is that risk towards a gap towards like 475.

18:41And that's not something to kind of scoff at because if you remember from November 1st until now, and the really big first start of the rally in both credit and then which helped out equities and everything else was 10s went from five to 3.75. Then it stabilized somewhere around four, four and a quarter. Nobody really paid attention. Like, all right, As long as tens are in the fours, low fours, and we'll keep buying stocks and equity and credit. But if it starts to go back up again and it doesn't feel like it's going to stop, this is where the trio of the three macros, which is the tenure rate, the dollar, and oil.

19:16Those three things can fast track a pretty big risk reduction in the market. And markets are priced really high and really extreme valuations. And that would also impact macro activity, too, and growth. So I'm really concerned about a gap on the 10-year. But given how much we've moved, I think we should probably consolidate a little bit here. We had the auction. We have a 30-year as well coming up. And I think cooler heads prevail. But if they don't, then the risk is that it will start to then impact risk assets even more severely. Because a 1 % move on the stock market is not a big deal considering what happened in the bond market today.

19:53The dollar. Chet asking, what do you see for the U.S. dollar in the next 6 to 12 months? dollar shot higher today. Yeah. So this is, and to go back to answering your bond question, I'll tie it back to the FX question. And it's, so the bond market now is also losing confidence, as you can tell, so we're pricing out the cuts and we're doing it in a very linear fashion. We're just, we're not assigning like, Hey, what if they do cut in July or September, then they take a break and then they come back to it. We're just pushing things back because no one really has strong conviction here. And positioning is really showing that.

20:27And just the flows where the price action, I think dictates that. So if the bomber just keeps pushing back the rate, the start or the first cut, then that just will further strengthen. It'll keep the dollar a bid throughout that period. The dollar can't weaken until the Fed starts cutting in a meaningful way. So, and then of course you have gold. And of course, I'm sure you have people that have questions around gold because that's completely going at odds with what rates are telling you gold should be doing. And then it brings up the question that is gold more of a medium-term outlook about, hey, we know the endgame.

21:00It has to be, eventually they're going to have to cut a lot more because the longer they wait, things are going to break anyway. And therefore, it's going to be financially inflationary, maybe not real inflation because they'll have to print money again. But while we wait, the bond market and the FX market are just kind of connected at the hip here where they need to just, you know, they push back cuts, then the dollar can't weaken. And that's an issue for all these countries that are now facing some currency pressure. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:37Yeah, and we have a, you know, we were talking about the potential for global banks to finally not move in lockstep. You know, this raises the issue that maybe some will move before the Fed. And if they don't, you know, both of them have potential outcomes. Is there an opportunity in there or is it more of a risk? How are you looking at that? I mean, like the cheapest like vol, and it's for a reason, has been FX volatility. So like FX vol could be like a hedge towards all other vol, like the VIX or rates. It's the last, it's been stable because the belief that everything's going to be synchronized and it's going to be smooth sailing.

22:19It's going to be a perfect soft landing everywhere. And then central banks are going to have kumbaya and cut rates. But if everyone goes at a different pace, that does create FX volatility. Yeah, so maybe one place to watch. So back to gold, if you think gold was sort of sniffing out past the part we're in now, and they're looking beyond that to say, all right, you know what? One way or the other, it doesn't matter. We'll get there. We're going to be in easing. I think you have a chart with forwards as well that have been not so sure that we're higher for longer. So is this just a timeframe issue?

22:54I mean, ultimately it is, because it comes down to when they start, how much do they cut and where do they stop, right? That's really what we're trying to solve for. And the bond market is super focused on that. And that's what we're debating internally. And that's why we're seeing these repricing happen so often. And these data points become very binary. Like today's a binary event. You go in thinking something on CPI and something else happens. I think, as I think I said at the beginning, I think it's an overreaction and the market wasn't probably set up the right way. But either way, the market moved.

23:25You have to respect it. But if you look at that page nine and look at like what the forwards have been telling us, the forwards are still telling us that, you know, the real neutral rate is somewhere around three and a half, four percent, at least short term neutral. I don't think that's the neutral for long term for where rates will be in the U.S. I still believe in some of the demographic issues. And we could debate the structural changes in the economy. But if we also embrace AI slash technology as disinflationary, a lot of these things kind of offset each other over time. And then you come back to almost square one that maybe rates are a little bit higher, but not that much higher.

24:02Meanwhile, the Fed still has rates at five and a half. But the bond market's been trading in the fours forever, signaling, hey, you're too restrictive. But this is not sustainable. and the forward rates have been saying the same thing. The question is, do you get there gracefully and you cut like 25 every other meeting and you really have that nice soft landing or do you end up realizing, wait, we were at five for too long and then they do 50 basis point cuts in the end of the year because they have to catch up. I think that's a great way of putting it, George, because the things that seem so at odd just may be, and it often comes down to this, the timeframe you're operating in.