To The Moon

Summary

• The market can't catch a break; even when the equity market is closed, more inflation data is announced.
• Used auto prices have risen by more than 4%, thus far in February.
• The bull's dream of immaculate disinflation is officially dead at this rate.

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Another blow to the disinflation narrative came on February 20, despite the equity markets in the US being closed. The Manheim used car data showed that used car prices rose by 4.1% through the first half of February. That is the most significantincrease in used cars since October 2021.

Bloomberg

The index rose to 234.0, the highest value since July 2022, when it stood at 239.6. It provides even further evidence that inflation is embedded within this economy and bubbling up again. The used car index price is up 7.5% since the November lower. This type of data will probably feed into the inflation expectations continuing to rise.

Inflation swaps have risen dramatically since the CPI report last week. The February CPI inflation now sees inflation at 6.01%, which is up from 5.78% on January 13, the day before the CPI report. Meanwhile, the March CPI inflation swap is trading at 4.98%, up from 4.85% the day before the CPI report. These inflation swaps tell us that the market expects inflation to be persistently higher than previously expected and that expectations for that fast roll-off in data may be far slower than expected.

Bloomberg

Even worse, the pipe dream that inflation would hit 2% by June is long gone. Inflation swaps for June are now 2.8%, up 80 bps from the January 9 low of 2.03%.

Bloomberg

The PCE report is expected to come on Friday as well, showing that inflation in January will also be hot. PCE month-over-month in January is forecast to have increased by 0.5% month-over-month from 0.1% and be up by 5% year-over-year, in line with the December reading. Meanwhile, core PCE is expected to rise by 0.4% month-over-month versus an increase of 0.3% in December and 4.3% year-over-year, down from 4.4% in December. That would undoubtedly be a big blow again to the hope that inflation would ride off into the sunset.

But more importantly, this presents a real problem to the bullish narrative because the higher inflation stays, the higher rates will have to go. Historically, the year-over-year PCE is still more than 1.15% above the 30-year Treasury rate. That has only happened two other times in recent history, in the fall of 1979 and the summer of 1980, and it was brief, and the PCE year-over-year was just 0.3% above the 30-year rate. The inflation rate hasn't exceeded the 30-year Treasury in modern history.

Bloomberg

However, long-term rates have been slow to rise because the market has believed that inflation would be fast to come down. But the longer inflation stays high, and the slower it takes to fall, the more likely it becomes that long-term rates will rise above the inflation.

On average, the 30-year rate has traded 3.12% above the PCE inflation rate, implying an 8.12% 30-year rate, assuming PCE comes in at 5% this week. So either inflation needs to start falling fast, or long-term rates will have to head much higher soon.

Bloomberg

This would have grave implications for the equity market that ran in front of the disinflation narrative. While it is not incorrect to believe that there is a disinflationary narrative because inflation is slowing, the question is how long it will take to come down and sticky it will be in that process. The longer it takes for inflation to come down to the Fed's 2% target, the more likely it is that rates on the long end of the curve will have to rise and the more damage that will cause to stock valuation in the long run.

Based on the data that continues to roll in, it appears the bulls will be wrong once again, just like they have been so many times since the beginning of 2022.