USCPI,ECB'spolicyand2003Iraq

We need to cover a lot of ground today as a lot of important data came in the last 24 hours. First was the US CPI, then US initial jobless claims about which we will talk through in detail. Then the ECB policy announcement and the size of the US Fed balance sheet will also form part of the discussion.

US CPI data which is one of the most keenly tracked numbers by the market. Though one should remember that the headline CPI is not the metric, which is tracked by Fed for its inflation objective, that is the Core PCE. But anyways markets account for such basis differences and assimilate the sentiments quickly. The headline number jumped by 5% YoY for the month of May, the core inflation at 3.8% (headline minus food and energy), food inflation at 2.2% and energy inflation at 28.5%. The chart present at the BLS site gives detailed information about the drill down at each sub-category in a very interactive manner. The headline number was more than the market expectations.

On the job front the initial jobless claims showed further decline at 376k for the week ending June 5. The number continues to drop for the sixth straight week but is still above the pre pandemic level. The seasonally adjusted level on March 14, 2020 was 256k. The continued claims number across all uninsured benefit programs stood at 15.35 million for the week ending May 22 which was a drop of 95k from the previous week.

Now if we tie up the above two data points together than it points to an economy where inflation is rising, and the unemployment is falling. In such an economy the policy prescription should be towards tightening, liquidity measures should wind up, rates should go up. All the asset classes at the largesse of easy money should fumble. But wait a minute before writing such advice let’s see what has actually happened. The stock markets went up, the Dollar index came down and the yields have remained steady. The market in all its wisdom has decided that the inflation reading will be described as transitory by Fed and they will not show any signs of policy course correction in the upcoming meeting on 15-16^th June. What constitutes transitory, we have explained earlier. As the economy opens up, there is pent up demand and play which is manifesting in supply demand mismatches and hence the price has moved up “temporarily”.

Readers should note that whether it was indeed temporary will be known only post facto, till then it is all conjecture. All these explanations hence don’t have much predictive power, they are given because the market moved a certain way. In case the yields had reacted negatively to the same data, another set of equally coherent sounding explanation would have been in place. Nassem Taleb describes this as the narrative fallacy in his book The Black Swan. He writes that as a race we have a crippling dislike for abstract hence append every action with “reason”. Sample this example from the book, about the news agencies flashes on the day of capture of Iraqi dictator Saddam Hussein.

3^rd July 2003, 13:01 : “US Treasuries Rise; Hussein capture may not curb terrorism”.

3^rd July 2003, 13:31 : “US Treasuries Fall; Hussein capture boosts allure of risky assets”.

Moving on to Euro, the ECB monetary policy meeting was on the expected lines. The standard text from the other central bank meeting reappeared here too, growth is good, but the future is uncertain. No tapering hint was given regarding the PEPP program. We have exhausted our word limit today and hence need to take the US Fed B/S size discussion in a later note till then let’s watch the treasuries and search for “reason”.