Producer prices rose by 0.5% in April, reiterating the theme that U.S. inflation is back on the rise and multiple data sources are confirming it (although the March number did get revised lower, offsetting some of that increase). The markets didn’t seem terribly put off or concerned about the number, which has been the case for a while, just how it impacts what the Fed might do with interest rates. Powell’s most recent message to the markets has been “be patient” and “let restrictive policy do its work”. That doesn’t sound like a central bank that’s ready to cut interest rates anytime soon. For as much as we criticize Powell about the Fed’s lack of appropriate responsiveness, holding rates is the right move and it sounds like that’s the path the central bank will take. Of course, conditions are very fluid as it relates to rates and the Fed’s position could still shift quickly. Perhaps Wednesday’s CPI reading will change things or a more rapid degradation in growth or the labor market.
Walmart and Home Depot will wrap up what’s largely been a favorable Q1 earnings season, but it’s also confirmed that the weakness in the retail space and, by extension, the consumer is a real thing. Home Depot missed expectations on Tuesday morning. Alibaba, while not a U.S. company, reported a profit decline of more than 80%. Walmart, which we’ll hear from on Thursday, might not do much better. This is just a continuation of the dichotomy we’ve seen between retail sales and spending figures, which keep looking relatively strong, and corporate earnings, which have been emphasizing a slowdown in consumer activity. The most telling number might be in credit card delinquency rates, which just hit a 12-year high and have nearly doubled in just the past two years. The only thing that’s perhaps saving this situation from getting worse is the resiliency in the labor market. Consumers tend to feel more comfortable spending money if they feel that their jobs are secure. Once that goes away, spending is likely to really slow down. The unemployment rate is now 0.5% above its recent low and April non-farm payrolls just missed by a wide margin. If this is the start of a deteriorating labor market, consumer health could deteriorate quickly.
As I see it, utilities and gold are two of the most important market indicators and they’re both telling the same risk-off story. After a period of digestion, gold has managed to resume its rally, but it's central banks that are accumulating positions more than retail investors, which is perhaps more concerning. As I’ve alluded to on YouTube, I don’t think the current rally in utilities is related to the increased electricity demand that’s anticipated to be needed for AI development or even interest rates. I think this is simply plain old defensive positioning in action. Utilities were kind of going it alone for a while, but the fact that consumer staples, low volatility, value and dividend stocks have begun to mirror the outperformance of utilities, the case is becoming more emphatic. Some may interpret the recent outperformance of small-caps as a risk-on signal, but I think it’s due to their heavier value tilt more than anything. Plus, small-caps have lagged large-caps since last year’s Q4 rally, so this isn’t really a new development. If inflation is on the rise again, I expect Treasuries to behave a lot like they did in 2022, which is to say not like a risk-off asset. That, of course, changes with a credit event or a further collapse in the yen, but it seems like it’s again an unreliable risk-on/risk-off indicator for the time being.
I’ve been talking for a while about how the Bank of Japan may be forced to further tighten conditions to save the yen even if it comes at the expense of slowing the economy. The central bank may be taking the first step in that direction in announcing a 50 billion yen reduction in bond buying this week. This is a relatively minor step towards policy tightening, as most have been by the Asian central banks, but it is in line with the BoJ’s desire to normalize policy conditions. The Japanese government has been very intent on strengthening the yen and this may be a good first step, but it can’t be the last. At least not if they want to make a real improvement in the value of the yen. For as much as the BoJ’s March rate hike made headlines, it did little to fundamentally alter conditions, especially considering that it’s still buying hundreds of billions of yen worth of JGBs on a regular basis. Perhaps this is the boat just starting to turn, but it’s got a long way to go still.
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