The turn higher in Eurozone (and US) sentiment indicators contributed to the global selloff in government debt last week. It is not clear that any major central bank has got a firm grip on inflation right now (not even the BoJ). The ‘immaculate disinflation’ narrative has faced a reckoning. The significant slowdown in inflation at the end of Q4 was a bit of a mirage.
Revisions clearly show that the Fed is making less progress on inflation than initially thought. The 3-month annualised rates for two measures of the core consumption deflator (including and excluding housing) were revised sharply higher in December, and re-accelerated in January, to 4.75% and 3.98%, respectively.
Ex-housing & energy, the services PCE price index rose 4.75% y/y. The short-term dynamics suggest further upside: prices for this measure – also referred to as ‘core core’ services inflation – rose 0.61% m/m and the 3-month annualised rate hit 5.58%.
Put simply, these numbers aren’t good for the stock market. The premium of the S&P 500 earnings yield over the 3-month T-bill (4.86%) has nearly evaporated. We are now close to reaching >4% across the entire US Treasury yield curve. It is plausible that 1.5% real yields are not restrictive enough, and that 2% TIPS yields are warranted for this US economy. If R* star has indeed risen, however, it is also worth noting that moves in R* are gradual and secular. The repricing in the Treasury market that took place in February was necessary and may have further room to run. But inflation readings such as the one in January now clearly raise the risks that the Fed becomes too hawkish, hammering the stock market. This may be one reason why the yield curve inverted further on Friday.
