Transcript of WARSH DROPS THE HAMMER: Why The Softest CPI in 5 Years Forces a Rate Hike!
Wall Street Truthbombs
0:00Wall Street just celebrated the lowest0:01core inflation reading in 5 years, but0:05inside the bond market traders just0:06priced an 87% chance that Kevin Warsh0:10raises interest rates next Wednesday.0:13While the networks are telling you0:14inflation is finally beaten, the yield0:16on the 10-year Treasury just raised0:18toward 5% locking your mortgage rate0:21near 7% and guaranteeing borrowing costs0:25go higher from here. Because the number0:27on your television screen is not the0:28number the Federal Reserve actually0:30targets. And the gap between those two0:32numbers is now running at the widest0:34disconnect in roughly, get this, 400:37years. My friends, stay with me. The0:40arithmetic is pretty simple and it's not0:42what you heard on cable news this0:44morning. I can assure you that. Now,0:46let's start with what you were told. The0:49August Consumer Price Index came in at0:524/10 of a percent for the month and 3.4%0:55over the year, both in line with0:58estimates. Core CPI, which strips out1:01food and energy, rose 2.4% over the1:04year. That's the slowest annual core1:06reading since the inflation surge began1:09back in 2021.1:12Five years of pain and the core number1:14is finally within shouting distance of1:17the Fed target. So, the surface story1:20pretty much writes itself. Inflation is1:22cooling, the Fed can relax. Gasoline did1:25the damage on the headline, up 3.9% and1:28accounting for over 1/31:30of the entire monthly all items1:31increase. Energy overall rose 2.1%.1:35Shelter, that's an important one, rose1:383/10 of 1%. Medical care actually fell1:422/10 of a percent. That's deflation,1:45right? Not disinflation, that's1:47deflation. Strip out the pump and this1:50looks like an economy where prices are1:52finally behaving, right? Well, then the1:56rates market did something pretty1:58strange. Within minutes of the release,2:00my friends, traders priced a quarter2:03point hike at the September 16th meeting2:05at roughly 85 to 87%. On Wall Street, we2:10consider that a pretty darn good bet.2:12Two full hikes, my friends, are now2:14priced in by year end. The 10-year2:17Treasury sits near 4.95%.2:20That is not how a bond market reacts to2:22good inflation news. Something in that2:25report didn't match the headline. And2:27when the bond market and the Chiron2:29disagree, well, the bond market is2:32usually reading a different page. Okay,2:35let's dig in further. But before we do,2:38if you rely on the real balance sheet2:40plumbing behind the headlines that2:42trading desks watch, you know what you2:44got to do. You got to hit like and don't2:46forget to subscribe because, my friends,2:48it's important to be in the know about2:49this stuff, and this is where you do it.2:51Okay, here's the first thing that nobody2:53put on the graphic. The Federal Reserve2:56does not target CPI. Those of you who2:59follow me long enough know that is a3:01fact. It never has. The official 2% goal3:05is defined against the personal3:07consumption expenditure price index.3:10That's a mouthful, but we call it PCE,3:13which is produced by a completely3:14different agency on a completely3:17different basket. And core PCE in July3:20came in at 3.3% over the year. That was3:23the last reading. Headline PCE came in3:26at 3.7%.3:28You read those two numbers again and you3:30see what I'm talking about here. Core3:32CPI 2.4%,3:34core PCE at 3.3%.3:38Wow, that is a gap of roughly 80 basis3:41points when you compare the same month,3:43and it's running in the wrong direction.3:46For most of modern history, core PCE3:48runs 30 to 40 basis points below core3:52CPI. Now,3:54that's a normal relationship. You see,3:56PCE is the friendlier number. It is the3:58one that lets the Fed declare victory4:00earlier. This year, that relationship,4:03well, it pretty much flipped. PIMCO put4:07the reversal at one of the largest since4:091985,4:11my friends. So, how does that happen?4:13Well, it's not magic. It is weights.4:16Shelter carries roughly 34% of the CPI4:20basket and only about 16%4:24of the PCE. Shelter, as you probably4:26know, is the one big category that has4:29been genuinely disinflating as the 20214:32and 2022 rent spike rolls out of the4:36annual comparison. So, every month that4:39shelter cools, and it's been cooling4:41slowly, but it's been cooling, CPI gets4:44a massive tailwind, but PCE, because of4:47the weighting, it's weighted much less,4:49barely even notices. You see, the CPI4:53number is not telling you inflation is4:55beaten, it's telling you one enormous4:57component is cooling and it happens to5:00own a third of the index. Meanwhile, the5:03PCE, the one that the Fed watches, leans5:06harder on the things that are still5:08really hot. Things like, well, you're5:09not going to be surprised here this,5:11healthcare, financial services,5:14technology. PCE PCE also counts medical5:17spending paid by your employer and by5:20the government, which CPI completely5:23ignores entirely because CPI only counts5:26what comes out of your pocket. And PCE5:30picks up portfolio management fees,5:32which rise mechanically when asset5:34prices rise. So, the Fed is staring at5:37an inflation gauge that goes up when5:39markets go up and that barely benefits5:42from the one thing that actually is5:44getting cheaper. Not cheaper, but it's5:47inflation is slowing down. That's5:50disinflation. And there is one more5:52wrinkle that makes this flip even5:54stranger. And this is an interesting5:56one. PCE is what's called chain6:00weighted. That means it rebuilds the6:02basket as people substitute away from6:05whatever got expensive. And CPI holds6:07its basket, that's the goods that it6:09tracks, much more rigidly. That6:13substitution effect is precisely why PCE6:16is supposed to print lower than CPI6:18almost all the time. So, when the6:20flexible index runs hotter than the6:23rigid one, the pressure isn't coming6:25from one stubborn category consumers can6:28dodge. It is broad. Now, the second6:31layer, and this one is the real tell.6:34The core CPI beat at 3/10 of a percent6:38against a 2/10 of a percent consensus,6:40it didn't come from broad price6:42pressure, it came from, this is going to6:44shock you. Well, maybe it won't. Your6:46phone bill. Your phone bill. Wireless6:49telephone services jumped 5.9% in a6:52single month. That's the largest6:54one-month increase ever recorded in that6:57single category. The communication index7:00rose 2.3% on the back of it. Wireless is7:03only about 1.3% of the basket, which7:05tells you how violent that move had to7:07be to drag the whole core reading up by7:11a tenth. We've seen this exact movie7:14before, but this just played out in7:16reverse. In March of 2017, wireless7:19services fell 7% in one single month.7:23The Bureau of Labor Statistics, we call7:25it the BLS, called it the largest7:28one-month decline in the history of the7:29index. It was the unlimited data price7:32war and a measurement quirk, not a7:35collapse in the cost of living. It7:37dragged core CPI to negative 1/10 of a7:40percent for that whole month and the7:42whole street spent weeks arguing that7:44inflation had died. Weren't they wrong?7:48The Fed looked straight through it and7:49kept hiking as you probably might7:51recall. The people who traded the phone7:53bill, well, they got steamrolled. They7:56got run over. Same category here, same7:59record book, but opposite signs. So, if8:02you're building your Fed call on a8:04wireless print, well, you're building it8:06on slimy sand. Now, here is the8:09uncomfortable part. The case for a hike8:11does not need that print at all. The8:14producer price data the producer price8:17index data released the day before tells8:20the pipeline story. Remember, it goes8:22from wholesale prices to retail prices.8:25PPI looks at wholesale prices at factory8:28gate, right? That's the stuff that would8:31be a leading indicator of CPI, what we8:34pay at the store. Final demand PPI on8:37its release rose 4/10 of a percent for8:39the month and 5.4%8:42over the year. That accelerated from8:444.8% the prior month. Did you hear that8:47word? Accelerated. Look inside of it and8:50you find that final demand goods rose8:511.1% in a single month and are up over8:54the year. Services rose 1/10 of a8:57percent. Energy rose, not surprisingly,9:024.2% and diesel fuel alone jumped 24.1%.9:10Accounting for over a third of the9:11entire monthly PPI increase. And inside9:14services, transportation and warehousing9:16rose 2.3% while trade services margin9:20fell 2/10 of a percent. That combination9:23is the freight squeeze showing up pretty9:26much in black and white. Now, diesel is9:29not a consumer price.9:31Diesel, and I say this all the time, is9:34the cost of moving every physical object9:36in this country. It shows up on your9:39shelf later, not now. The 7.7% annual9:44rate on producer goods prices is loaded9:46is a loaded spring, my friends, sitting9:49behind a consumer index that everyone9:51just declared tame. All right, stop and9:54ask yourself who's actually under9:56pressure here. It's not the economists,9:58it is one man with a podium and a10:01credibility problem. You know who I'm10:03talking about. That's right. That's10:05Chair Kevin Warsh, and he has spent his10:07entire tenure saying there is still work10:10to do on inflation. And the data just10:13handed him the one thing a central10:15banker just absolutely cannot ignore.10:18The University of Michigan preliminary10:20September survey showed up showed10:22consumer sentiment collapsing to 47.810:26against an expected 51.0.10:29That is the weak part. Here's the10:31dangerous part. One-year inflation10:33expectations jumped to 4.6%10:36from 4.0. The five-year reading sat at10:393.4%. That's the number that ends the10:42debate. A central bank can tolerate a10:45hot month, it cannot absolutely cannot10:48tolerate households beginning to believe10:50that high inflation is permanent because10:53that belief is what turns a price shock10:56into what we call a wage-price spiral.11:00It's a dangerous thing and it scares11:02central bankers out of their seats.11:04Expectations are the only variable that11:07the Fed truly owns and they're slipping.11:10So, what does this mean for real money?11:13Well, let's start with Well, here comes11:15again, bonds.11:17If the Fed is hiking into a consumer11:19sentiment reading of 47.8, that's a11:22central bank prioritizing credibility11:24over growth. The front end gets punished11:27first and the curve flattens. That's11:29exactly what happens when two-year notes11:31underperform on the print? Holding short11:34duration paper because it feels safe is11:36the trade that quietly hurts here a11:38little bit. Now, equities. A 10-year11:41near 4.9%11:43is a discount rate problem for every11:46long duration growth story in your11:48portfolio, and I know you own lots of11:52those stocks. We all love those stocks.11:54The market spent this year paying for11:56cash flows that arrive in 2031. These11:59are companies that have great growth and12:01great promises, but they're not today,12:03not like the staples companies. We're12:05talking about technology companies and12:06growth companies that have great12:08stories. Those cash flows are worth less12:11every time that yield on that 10-year12:13and a higher kicks up. And because12:15portfolio management fees feed into PCE,12:19wow, this is crazy, a rising market12:21literally feeds the inflation gauge that12:23justifies the next hike. That's the loop12:26that nobody wants to say out loud. I12:29hope you got that concept. Then let's12:32talk about credit. The 30-year mortgage,12:34something that we talk a lot about, does12:36not track the Fed funds rate. It tracks12:38the 10-year. So, every basis point the12:41long end adds on inflation fear goes12:43straight into housing affordability,12:46which freezes existing home supply,12:49which eventually puts a floor under the12:51shelter component that has been doing12:52all the disinflationary work in the CPI,12:56if you remember from the beginning of12:58this video. That's the snake eating its13:01own tail. The cooling in the CPI13:04headline depends on a housing market13:05that higher rates are actively jamming.13:08Then there is the household channel.13:11Gasoline, well, here you go, up 3.9% and13:15diesel up 24.1%.13:18I almost had an urge to curse there, but13:21I'll let you fill in the blanks. It is a13:23tax on the people with the least13:25cushion. Food prices are up 2.7% over13:28the year on top of everything that came13:30before. And gold, holding near 4,40013:33bucks an ounce, is not a bullish signal13:36about growth, my friends. It is capital13:38buying insurance against the idea that13:40the 2% target is now, well, simply13:43aspirational.13:45Now, let me argue against myself because13:48that is the job. The strongest case13:51against a hike is sitting in the13:53producer data.13:55Core PPI, excluding food and energy,13:57rose only 2/10 of a percent, below the14:003/10 of a percent consensus. Those are14:03the components that feed directly into14:05PCE. So, the August core PCE print could14:10actually land soft. I know this is14:12getting a little bit complicated here,14:13but you got to trust me on this. Now, if14:16you add the wireless distortion that we14:18talked about, that will almost certainly14:20reverse, and a diesel spike that is14:23supply shock rather than demand, right?14:25It's all coming from the issues in14:27Hormuz. And then maybe, maybe you can14:30build a real argument that hiking here14:32could be a policy error into a weakening14:35consumer. I would be wrong on this14:37thesis if wireless gives back its gain.14:39Of course, if August core PCE prints at14:422/10 of a percent or less and pulls the14:43annual rate toward 3%, and if one-year14:46inflation expectations fall back under14:484% in the final Michigan reading.14:51Remember, Michigan releases twice a14:52month. Our Friday's was the preliminary,14:55toward the end of the month and it gets14:56revised possibly. Watch all three of14:59these things. Here is where the actual15:01they they actually are we actually are15:03right now. The consumer price index is15:05cooling for one structural reason that's15:07already largely played out. The gauge15:10the Fed actually targets is running15:12nearly a full point higher. Producer15:15good prices are accelerating at 7.7%15:18and households are starting to bake15:20higher inflation into their own15:22expectations. Ah, put your eyes on three15:25dates, my friends. The FOMC decision15:28next week on September 16th, the August15:30personal income and outlays report with15:32core PCE on September 30th. That's the15:35update for the PCE. And the next CPI15:38release, which of course comes in a15:39month from now pretty much around15:41October 14th. Those three prints, well,15:43they decide this is one is15:46a hike or the start of a cycle, right? a15:49one-time thing that we're going to get15:51or is it the beginning of sometime15:53longer longer print regime, okay? A15:57hiking regime, excuse me. All right. So,15:59your truth bomb for today is this. It16:01was a complicated one. The Fed is not16:03hiking because inflation came in hot.16:05It's hiking because the only inflation16:07number that could that cooled is the one16:09that it does not target. When your phone16:12bill is setting monetary policy, the16:14market is pricing the wrong index16:16entirely.16:18My friends, join me every day for Wall16:19Street truth bombs where I drop them16:21right here before the market figures16:22them out.
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