New York, NY, InfraCap Market Update - Many commentators and analysts refer to inflation as being "sticky" or that inflation can spontaneously spike. The notion of inflation suddenly accelerating comes from the 70's where the Fed finished a tightening cycle in the middle of the decade, but then inflation suddenly spiked in the late 70's. What economists did not understand in the 70's is that oil prices bleed through to core at approximately a 5% rate. The inflation spike was not spontaneous but rather was caused by a 200% spike in oil prices after the Iranian revolution. In fact, oil prices increased by an unimaginable amount of 1,200% during the decade, driving 90% of the inflation for the period. The price spike was exacerbated by strict price controls on US production that caused a decline in US production despite higher global prices.
Inflation is caused by loose monetary policy that results in increases in housing prices and rents as well as supply shocks that have historically been driven by energy and food prices, but post-pandemic have included chip prices, auto production, and other manufactured products impacted by the Pandemic. The recent slight uptick in inflation was driven by a recovery in oil prices after a warm winter and persistent vehicle-related services inflation that is primarily driven by the post-pandemic decline in auto production.
The other component of inflation that has caused inflation to remain above the Fed's target is shelter. The BLS methodology is archaic and highly flawed with a deliberate 6-month delay built into the estimate. If shelter inflation was adjusted to reflect market rents readily available from internet rental companies, shelter inflation would be negative .8% vs. the 5.7% Y/Y number reported by the BLS. If shelter were to be adjusted, headline CPI inflation would be 1.2%, core CPI would be 1.1%, and Core PCE would be 1.6%.
The Fed is in the process of committing yet another policy error due to its overly rigid and arbitrary policy of targeting a 2% Core PCE inflation rate without considering the accuracy of the estimate. Moreover, the 2% target is completely arbitrary and has been shown to be too low by academic research (research paper available at www.infracapfunds.com). By delaying rate cuts, the Fed is risking an economic slowdown despite inflation clearly being contained.
We expect the ECB to cut rates in June as the Euro Zone does not suffer from flawed estimates of inflation and the Euro Zone economy is entering a recession. We do expect the Fed to cut rates at its July meeting as we forecast Core PCE will finally roll down to approximately 2.5% by the end of June, giving the Fed comfort that inflation is heading to its 2% target. We project that global rate cuts will lead to a $2 trillion injection into the Global Monetary Base and spark a rally in stock and bond prices during the summer.