The Inflation Problem

It’s great sport to criticize the Fed for what seem like bone-headed moves. Yesterday wasn’t one of them. What Powell knew and rest of us had guessed was that June CPI was headed significantly lower and would continue to widen its divergence with core CPI.While the futures were ramping higher thanks to Powell’s dovish prepared remarks (which were conveniently released prior to the open)… …few stopped to question why the Fed should ease amidst the most accommodative monetary conditions since 2013.

The fact is that Powell was boxed in.  Everybody knows that the official inflation data woefully understates actual inflation.  This comes in handy when trying to keep a lid on interest rates — a necessity when you’ve got $22 trillion in debt and a $1 trillion budget deficit.

But, even flawed CPI is an important signal.  It goes a long way toward explaining why oil and gas prices magically decline every time inflation starts to get out of hand……and inflation magically declines every time interest rates threaten to get out of hand.

Put them together and RBOB’s 42% Oct-Dec 2018 plunge (which began only 2 days prior to the 10Y topping out) suddenly makes a whole lot of sense.Unfortunately, understating inflation is not convenient at all when investors start worrying about deflation — as the current interest rate environment suggests they do.

Trump & Co. say they want low interest rates and a cheap dollar. Plunging oil and gas prices are the best way to get there. The latest CPI print at 1.65% is testament to how well the mechanism worked.  Score one for the White House.

Sure, the trade war, real estate bubble and rising health care costs are bumping Core CPI higher.  But, the average voter couldn’t tell you what “CPI” stands for, let alone the difference between the various inflation measures.  And, the average investor only cares about inflation if the Dow should happen to slide more than a few percent which, if it occurs, is easily negated by a breathless update on the excellent progress of the trade war negotiations.

Bottom line, the Fed would face heavy criticism if they stood pat with CPI at 1.6% and falling.  The White House is no doubt well aware of this, and is also well aware that YoY comparisons will be pressured by oil and gas’s recent rallies — particularly when October arrives.

This is why oil and gas prices are very unlikely to continue to rise — as the charts confirm.

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