A benign inflation number - now what?

Inflation numbers were within expectations, yet this is not something to celebrate. Core inflation is still above the 2% target, and headline inflation is still above 3%. Has the Fed been successful with its policy? The answer is no. However, the current inflation numbers suggest that no action will be taken at the September FOMC meeting. Policy changes are unlikely before an election, and that will take us to the end of the year to see any policy rate change. 

The important monetary policy information will come from the Jackson Hole conference and any headway from the five task forces reviewing policy. Chairman Warsh, if current behavior is a guide, is unlikely to tip his hand about policy at the Kansas City Fed confab, so the market will have to make decisions for itself on the direction of rates.

TIPS yields continue to move higher

 

It is not just nominal yields that are moving higher. Real yields have also been on a steep ascent, with levels at the highest in ten years. In fact, to get to these real yields, investors will have to look at data prior to the GFC. We are in a strong situation where real yields are telling investors that we have tight monetary conditions, yet inflation and nominal yields suggest that concerns about inflation are real. This places the Fed in a difficult policy environment and clearly is a reason for FOMC voting disagreement. 

Yen intervention can buy time not a solution

Always bet against intervention if there is no change in policy. Now, this does not mean you should fight a central bank in the short-term. It does mean that intervention has to continue if it is to work. Central banks are much savvier with their intervention. It will occur when there is limited liquidity. It may come through markets not expected, like EUR/JPY instead of USD/JPY. It will be followed by rhetoric to reinforce resolve. It will occur through selected banks to ensure not all are harmed. 

It can buy time but it cannot buy a solution.

AI investment follows other boom and bust cycles

Booms or bubbles are often associated with excessive investments. The euphoria associated with a new technology or meme leads to significant money flows. But there is a marginal return on the capital that falls as more investment dollars flow into the theme. The excess investment leads to a large capital stock in the new technology that may have significant positives for an economy, yet that does not make it a good investment, especially for those that come late to the investment cycle. Is new money late to the cycle? There is not a definitive answer, yet it is clear that all of the capital chasing returns will not be rewarded and likely will be a bust. 

Canals, railroads, new tech in the 20s, and the dotcom boom all saw significant capital investment, yet for many the rewards were limited.