Word of the Day: “Transitory”

According to Merriam-Webster, “transitory” is an adjective that means “of brief duration” or “temporary.”  Used in a sentence: Investors believe that the Federal Reserve will continue to view inflation as transitory.

If you had any doubt about the market’s ability to put a positive spin on almost any piece of news, today’s response to the Consumer Price Index (CPI) report should put that to rest.  To recap, here are this morning’s statistics:

	Expected	Actual
CPI Month-over -Month	0.5%	0.9%
CPI Ex Food and Energy MoM	0.4%	0.9%
CPI Year-over-Year	4.9%	5.4%
CPI Ex Food and Energy YoY	4.0%	4.5%

On the surface these look like big misses, scary even.  Yet as I write this about one hour into the trading day, the S&P 500 Index (SPX) is roughly unchanged on the day and the NASDAQ 100 Index (NDX) is about 1/2% higher.  The front end of the yield curve is acting as one might expect, with 2 and 5 year Treasury note yields rising about 2 basis points, but that is offset by 10 and 30 year rates falling by a similar amount.  What gives?

We provided the short explanation in our piece yesterday: “Lower rates on longer-dated fixed income have been used as a valuation prop for the mega-cap technology stocks that make up the majority of the NASDAQ 100 Index (NDX) and a significant percentage of the S&P 500 Index (SPX). Investors seem to be able to put a gloss onto mega cap tech stocks no matter what, and it is hard for major indices to fall if those stocks rally.”  The fuller explanation is more complex. 

Economists and traders immediately began poring over the release to see which categories had the biggest influences on the numbers.  One statistic that leapt out was a rise in used car prices.  The thinking is that the used car market is under temporary stress after many urbanites moved to the suburbs and began returning to work, while at the same time there are supply chain backlogs affecting the availability of new cars.  That really does seem to be the epitome of a temporary inflationary pressure.  (As an aside, your best performing asset may be sitting in your driveway.  Used car prices are up over 17% during the past 3 months, compared to a rise of 5.8% in SPX and a drop of 47% in bitcoin.)

Also, the Bureau of Labor Statistics also released a statistic showing that real average weekly earnings fell 1.4% in June.  The obvious explanation is that headline inflation rose faster than wages, but the rosy explanation is that wage inflation is the least transitory type.  Thus, if wages aren’t keeping up with the overall level of inflation, it is easier to classify the current inflationary pressures as transitory.

Since we can explain the NDX and SPX performance by the dip in 10 year rates, what explains that move?  The logic is not particularly intuitive, and again requires a positive spin from bond traders.  The short end is telling us that traders fear a slightly quicker move toward some monetary tightening.  That makes perfect sense.  But traders also seem to think that the Federal Reserve can engineer a situation where that quick action will keep a lid on inflationary expectations and keep moderate growth.  Is that possible? Of course.  But it would require extraordinarily deft handling by the Fed.  Markets that are willing to put a positive spin on all news would also put their faith in a nearly infallible Fed.  Only time will tell if that faith will be rewarded, but history is filled with central bank missteps even when the ultimate outcome is the one that the markets desired.

For today at least, traders have convinced themselves that inflation is transitory because much of the increase in CPI can be explained by rising asset prices.  The market is placing its bets that asset prices can’t continue to grow indefinitely.  Or are they?  Are stock and bond prices asset prices that don’t decline while pesky things like lumber and used cars can?  Please ponder that if you are considering that asset prices are making inflation transitory.