Is Inflation Disappearing?

0:00People are going to lose their minds. This is a moment in history unlike anything humanity has gone through. It's a very different world for humans to come. Take a step back and see the broad picture, which is the way all these technologies are interlinked. Because this is all about exponentiality, and humans can't think in exponential terms. How consequential do you want to say machine intelligence is? It's almost certainly as consequential as writing. How long did writing take to disseminate through the human population? You know, hundreds, thousands of years. And we're dealing with it now on a scale of months.

0:33But in this kind of world, you're compounding 100 % growth every year, and the numbers become astronomical. AI is going to spot patterns in the world that were just completely invisible to us. Even if you think that the AI and the robots are your demise, you might as well bloody invest in them and make some money out of it. If not, you're just going to be angry man shaking your fists at the clouds.

1:07the signals are telling me that inflation is no longer a worry welcome to this live edition of steno signals here at real vision my name is andrea steno the host weekend and week out of this show and um oh boy we've had some action in inflation markets and of course in interest rate markets as a consequence of the inflation numbers out this week both from the UK and the US So I'll dedicate the next 15, 20 minutes to talk about the inflation outlook, because on the surface, and given how markets react, it seems like inflation is gone as a worry for financial markets. I'm not necessarily sure that we can claim victory in the inflation battle in the US, but the signs are pretty steady elsewhere around the globe when it comes to inflation pressure.

1:58So let's have a look at the details across the globe with a particular focus on U.S. inflation. So if we look at the inflation report from the U.S. this week first, it was soft on the surface, 0 % inflation on the month, so steady prices. And if we look beneath the surface, I have a lot of details in the chart here. We have quite some discrepancies across the trends we see currently. Obviously, energy was a major component in the disinflation this month. Energy sort of deducted 0.3 percentage points of the inflation number relative to a month ago. So energy was a large component behind the softness in the inflation report.

2:44Medical care services was another soft inflation component, not least due to the change of methodology from the Statistical Bureau. the cost of health insurance was down 35 % year over year. Obviously, that's not the case in real life. It's driven by a change of methodology. So there are a few pros and cons in terms of expecting inflation to be gone as a worry in the US from Europe. First, if energy inflation returns, say in November and December, will be back at levels consistent with above 2 % inflation very swiftly. Secondly, this medical care disinflation is probably not something that the Federal Reserve will accept since we will not see the same drop in the PCE price index, since there will be no change to the methodology in that index.

3:40And we should remember that the PCE index is the ultimate target variable of the Federal Reserve. So ultimately, what I'm trying to say here is that I think it's too early to just claim victory against inflation in the US. The response that we see in dollar interest rate markets is probably a bit exaggerated here, especially in the front end, given these technical details around the inflation outlook in the US. If we look at the same chart on the inflation details from the UK, today, I'm probably a bit more inclined to say that we see broad-based disinflation in the United Kingdom. The broad-based disinflation is clearer.

4:25We see services, for example, as a category printing at levels roughly consistent with the inflation target now over the past three months. So we had 0, 05, and 03 as the monthly changes. On average, that's pretty decently in line with the target. We have goods inflation also running at levels that seem palatable from an inflation targeting perspective. And we don't have any major shocks in the opposite direction in the UK. And it rhymes well with the narrative that I've toured with over the course of the autumn here that inflation in Europe looks likely to drop below 2 % into the early stages of next year, while it's much less clear whether that will happen in the US.

5:08So if we take the Eurozone as the final example, also the table of details in the most recent inflation report out of the Eurozone, it printed at 0.1 month on month, again, very broad based across categories. It wasn't as energy driven as it was in the US. And we even have outright declining trends in, for example, recreation and culture, restaurant and hotels, core service stuff. And the service inflation picture is obviously what worries the central bank the most. So I still think the scope for policy easing is much more present in Europe and in the United Kingdom relative to the US, even though it seems like it's a bit of a global trend right now that every central bank on earth is on pause.

5:57I think that narrative will be tested at some point over the course of the next three to four months in the US. Here's why. If we look at a chart on the path to 2 % in the US first, it's a very simple scenario analysis, this chart, that we'll bring up now with the paths of annual inflation given various monthly numbers. So take, for example, the black line. It is the scenario of 0.6 % inflation on a monthly basis from here over the next six months. So as you can see, even with the light blue scenario, 0.1 percentage points of growth in inflation on a monthly basis, we will not get to 2 % in six months from now.

6:45So it is a very tricky path ahead, and you basically need no inflation from here. So 0 % inflation month after month after month over the next six months to get below 2%. And I still consider that very unlikely unless we get continued energy disinflation. I'll get back to why I consider that unlikely towards the end of the show. So the path is very tricky to that 2 % level in the US. Is it feasible in the UK? Same chart with scenarios. And as you can see, the 0.1 percentage point changed month on month. brings inflation below 2 % in the UK by early Q2 next year. And 0.1 % inflation looks much more feasible in the UK than it does in the US since it hasn't been as energy-driven lately.

7:35And since we see that broad-based decline in the sort of momentum in prices, both across services and goods. So is it feasible that the UK gets 2 % inflation by, say, April next year? Well, I wouldn't rule it out, at least. I basically rule it out for the US. And when it comes to Europe, finally, or the eurozone, rather, I think we should expect inflation to actually reach sub 2 % levels or at least levels very close to 2%, following a path of, say, 1.1 percentage points of growth per month. By March, April next year, given that path, we will be at plus minus 2%, so very close to target, meaning that the European Central Bank can probably cut interest rates by March or thereabout.

8:26So it also rhymes with my positioning in the portfolio right now. I'm long bonds in Europe, while in the US, I'm a bit more selective on which bonds to buy, even though we've seen tremendous performance lately. We'll get back to the portfolio composition towards the end. We're going to take a quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

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9:52If we look at it in various forward-looking indicators, they do also rhyme with my view here that it will be trickier for the Federal Reserve to bring inflation to target relative to the developments in Europe. If we look at PPIs first, so essentially the price pressures in the producer leg of the supply chain, we do see quite a discrepancy between the development in the US and in the Eurozone. The Eurozone is a gray line here printing at below minus 10%, so a substantial drop on a yearly basis. And we have the US running at above zero in sharp contrast to the developments elsewhere. So the automatic spillover from the producer leg to the consumer leg is not as crystal clear in the US as it is in Europe, where unless margins are widened materially, we will see disinflation, maybe even a risk of outright deflation in some categories as a consequence of lower input costs.

10:56Of course, this tide can turn if energy inflation returns with a vengeance. For now, it seems like a sort of an unlikely scenario, at least to the extent that we were used to in 21 and 22 in Europe. If we look at the US in isolation, I have a chart on the food prices relative to the producer leg. And I think what you should note in this chart, even though it looks very deflationary, is that we have seen a bottom forming in the producer leg in the US. In this particular case for fertilizers, of course, of relevance in everything related to foods production, chemicals, etc. We saw that bottom forming in October.

11:42And even though it has sort of flatlined since, it basically means that the impulse from weakness in producer prices is here and now. the impulse will not deliver into Q1 next year, as we've seen a bottom in price pressures for the producers. And that is the first sign of cyclical pressures building again in US inflation. And I think we should expect more of the same into next year. We also see, in my view, a bottom forming in the contributions from energy on a year-over-year basis. The energy inflation in the U.S. index is relatively easy to forecast as long as you follow the spot developments in the U.S.

12:36energy markets. And again here, the bottom was likely found earlier this autumn, while the contributions will not be net negative on a sequential basis from here. So the easy disinflation is behind us. It was easy to get like 7 % to 3%. The tricky part is to get from 3 % to 2 % because you don't have those benign tailwinds from disinflation in energy, from disinflation in cyclical goods, and disinflation in the producer leg. We should also note that some of the early trends seen in, for example, used cars, they're also around a turning point now. The Mannheim Index, so basically an index of used cars auctions, also seems to flip into year-end, as you can see from the dark blue indicator here.

13:32And it tends to lead the developments in the CPI index of, let's say, roughly four months. And again, here, we've had the benign moves. The path ahead will be trickier than the path that we've just been through. And I think that's overall the story. Now that we've seen this very soft inflation print, which was basically smack dab at my forecast, basically. But now the tricky path is ahead of us. The easy path was just behind us. and therefore some of the trends that we see in the market this week, a week or dollar, very strong returns in bonds, a celebration across technology and everything interest rate sensitive in financial markets.

14:17It makes sense. We also talked about it last week on the show that technology should perform as a consequence of this lower inflation, as a consequence of the softness in interest rates. But I think it will be trickier to find strong returns in technology in the months ahead of us due to this flip or turnaround in the trends in forward-looking indicators on inflation. It's not because I think inflation will return with a strong vengeance, but I think from a way of change perspective, we're about close to the bottom now. So the best leading indicator of that, we've spent time on elaborating on this indicator in the business cycle series here on Real Vision a couple of times.

15:02I think the best indicator is the so-called price plan survey from the NFIB. and the NFIB asks this question to members, mostly in the service sector, in the SME space. And therefore, this is sort of a clear underlying trend survey when it comes to price pressures, because they asked this question on price plans ahead to companies with a large component of wage costs relative to goods. And as you can see, there is a bottom forming in this survey. We received the latest print from the NFIB on Tuesday, a couple of hours ahead of the inflation report, and we saw another spike in price plans. So basically, companies are telling us that they expect to price their products in a more expensive way into next year, or at least a net aggregate of the respondents tell us that.

16:02So as you can see, there is a pretty decent correlation to the median of the CPI basket. And as you note on the left-hand scale, the median will never get back to 2 % if this forward-looking indicator is to be trusted. And I put a lot of trust in this one. I think it's one of the best forward-looking indicators out there. We can also use the labor market as a gauge of core inflation pressures. And if we do that in the US, for example, by judging inflation pressures via the job openings to unemployed ratio, I still think that we're hovering around levels that are consistent with, as you can see on the right-hand axis, say 4 % core inflation or thereabout.

16:46And we need substantial weakness in the labor market from here to get to 2%. That may arrive next year. I'm still not confident that we will see sufficient weakness to get us to 2 % short term, which means that the Federal Reserve will still have to decide on whether to deliver this rate hike that they originally planned upon for December, especially if US key figures start to re-accelerate into year-end and if US key figures also start to see an impact of higher energy prices again. We're going to take another quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

17:30That's the final theme of the day. And I want to emphasize the relevance of this theme because we've seen a landslide, almost at least, in the oil price through the latter parts of September and through October and into November. The major catalyst behind the move downwards in the oil price was the weakness in the manufacturing sector through the month of October. So the ISM manufacturing printed at 46 and a half thereabout, below the 50 threshold of expansion versus contraction. It was a setback relative to the underlying improvement that we otherwise saw through the early autumn. And if you look at that survey relative to the oil market, It is now clear that we have a downwards trend in the oil market also when it comes to positioning.

18:23So the paper market in oil is now net short oil again. That's what you see on the right-hand axis here. We have more short contracts than long contracts in future space. And on the left-hand axis, you have the ISM P &I. So the current positioning is roughly consistent with 46, 47, thereabout in the ISM manufacturing. But I think the manufacturing number was a fluke or phony or whatever you call it in English in the month of October because it was very driven by this sharp sell-off in bonds that we had when the issuance report was released earlier in Q3. So we had first a move higher in interest rates during the survey period before now moving much lower in interest rates.

19:10So the survey was conducted at a very peculiar timing or a very tricky timing, given the fast tightening of financial conditions at the time. So I think that impacted the survey quite a lot. And now we have much easier financial conditions again, just say three, four weeks after, which will likely spill over to a positive mood in that survey again in November. And on top of that, we also had the Energy Information Agency, the EIA, claiming that the gasoline demand fell off a cliff in September and early October. That was the other major catalyst behind the sell-off in the oil market. And it now shows that this was indeed fake news.

19:59pardon my French, but if we look at the numbers now corrected for seasonality and corrected for the full information through the month of October, we've seen a complete rebound and even the demand is now even exceeding levels prior to that demand cliff that we saw in September and early October in this data. So what happened? Well, I think there was some hesitancy from refiners basically spilling over to inventory data in the gasoline survey here. But now that we have the full data set, now that we have the seasonality corrected, we know that the demand for gasoline was high. I never trusted the number in the first place because you can look at actual congestion.

20:45You can look at numbers of cars on the road. You can look at port activity. You can look at flight data. And none of it suggested that the demand for transportation fuel was down. So it was ultimately some sort of spreadsheet error, likely driven by this hesitancy among refiners. And now we're back at levels prior to this sell-off. So the demand side was never weak. And therefore, I'm a bit puzzled, actually, to see the oil price down here. I think it's very driven by the paper market. And therefore, I've just bought oil 30 minutes ago in anticipation of a move higher on the back of this data correction.

21:29And final thing that supports that thesis is the numbers that we've received from regional federal reserves, Philly Fed an hour or two ago, and the Empire Fed in New York yesterday. Those two regional PMIs rebounded materially in November, just as I described that October was probably a data glimpse due to the storm in financial markets right around the survey dates. Now that we have more benign conditions, the survey will likely look much more positive this month. And that's another strong signal that the oil demand is at least not declining from here, say over the month of November and December.

22:0824 is another discussion for now. So I think we will see a late year spike in energy prices due to a repricing of the manufacturing outlook in a positive direction again, and due to a repricing of the transportation fuel demand after the data correction from the energy agency. So my portfolio, and sorry, I haven't updated it with the latest purchase of oil year 30 minutes ago, but long oil and long duration in Europe, so long 20-year plus bonds in Europe in anticipation of inflation reaching sub 2 % levels early next year. And then in the US, I think the right move in bond space is to buy TIPS.

22:51So basically, inflation protects treasuries. TIPS will perform if the inflation expectations go up, say alongside a small spike in the oil price, while the Federal Reserve will be hesitant to react to it. And I think that's a cocktail that seems very likely here. Also, when we have those, say, short-term tailwinds for industrials, towards the end. Again, 24 is another discussion. I think the recession will arrive in 24. But these short-term tailwinds for industrials, they spill over positively on Germany. Germany has been prized for a complete disaster scenario. And if you look at the iShares German ETF, it's been rallying like crazy and also outperforming peers in recent weeks.

23:40I've enjoyed that rally, thankfully. And I think more is on the cards. if this short-term positivity around manufacturing and the sort of cyclical components of the economy will sort of lead the economy into year-end here. So those are the major takeaways right now. Inflation will be tricky to get back to 2 % in the US. It will be easier in Europe. We should expect some kind of repricing in a positive sense of the manufacturing outlook and the energy prices as a consequence. And those are the main themes for me from here on until year end. Into 2024, I think we see more and more signs of the consumer caving in.

24:25Maybe that spike in the oil price will be the sort of final straw that breaks the camel's back. So with those words, let me remind you that this is just a window into my thinking on macro trends. I cannot guarantee you that you have the same risk appetite or the same risk horizon as I have. But what I can guarantee you is that we cover these macro trends on a weekly basis here at Real Vision. And if you like what you saw, you can find out more about Stida Research. And we have the exclusive offer, RV40, for those of you interested in following the portfolio live and for those of you interested in reading my research on top of watching this show.

25:04Thank you very much again for watching. If you have any comments or themes that you would like me to touch upon, please leave them in the comment section and I'll make sure to include them in next week's show. See you again next week. People are going to lose their minds. This is a moment in history unlike anything humanity's gone through. It's a very different world for humans to come. Take a step back and see the broad picture, which is the way all these technologies are interlinked. Because this is all about exponentiality and humans can't think in exponential terms. How consequential do you want to say machine intelligence is?

25:38is almost certainly as consequential as writing. How long did writing take to disseminate through the human population? You know, hundreds, thousands of years. And we're dealing with it now on a scale of months. But in this kind of world, you're compounding 100 % growth every year and the numbers become astronomical. AI is going to spot patterns in the world that were just completely invisible to us. Even if you think that the AI and the robots are your demise, you might as well bloody invest in them and make some money out of it. If not, you're just going to be angry man shaking your fists at the clouds.

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27:12Visit 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. Plus500. It's trading with a plus.