Headline Inflation Could Top 4%

Jeffrey Gundlach says Headline Inflation Could Top 4% by June.

Headline CPI inflation is almost certain to rise above 3% in June and July, according to Jeffrey Gundlach. It could even top 4%, he said, which would “really spook the bond market.”

Gundlach spoke to investors via a webcast, which he titled, “Looking Backward” The focus was on his flagship total-return fund (DBLTX).

There is no inflation in core CPI, Gundlach said, but headline inflation will increase significantly and will be greater than 3% in June and July. The Fed is aware of this and is telling the bond market it is unconcerned, according to Gundlach, and welcomes that level of inflation along with the accompanying negative interest rates. This allows the deficit to be financed with cheaper dollars, he said.

Headline CPI could even go above 4% over that time, he said, based on ISM data, which could trigger a bond selloff.

To get inflation, Gundlach said we need to give everyone a “Bellamy credit card,” which was portrayed in Looking Backward. It would essentially be a stimulus handout to Americans that must be spent over a fixed time or returned to the government.

“It’s shocking that households with $150,000 of income and three children will get $6,000 from the government,” he said, in reference to the $1.9 trillion stimulus. “This looks a lot like a monetizing experiment.”

Gundlach On Speculative Bubbles 

We are in a speculative bubble in government debt and equity valuations,” he said. If there is a collapse in stock prices, it will not be 10 or 15%, but a “large number. There will be a tremendous unwind of stock positions.”

He also stated the "VIX will hit its highest level in the next correlation and will go over 100.”

I agree with his opinion on speculative bubbles, but a VIX over 100 might be overdoing it.

And if stocks crash, so will consumer spending and US treasury yields. Inflation will be the last thing on the Fed's mind, except how to get it. 

3% to 4% CPI Inflation By June?!

Gundlach is referring to year-over-year impacts, not a sudden spike of 3% in one month.

Easy Comparisons

It's not that inflation will be rampant. 

Rather, it's the impact of year-over-year comparisons, goosed by a huge Covid-related dip in energy prices in April and May of 2020.

CPI Select Indexes Not Seasonally Adjusted 

CPI Select Indexes Not Seasonally Adjusted 2021-02

The huge dip in energy prices in April and May of last year only made a tiny dip in the CPI that month as shown on the chart. 

This happens because motor fuel only accounts for 2.88% of the index. The broader "Energy Index" is only 6.155% of the CPI. 

It takes a huge swing in smaller components to impact the current CPI much, but the year-over-year impact is another story.

Year-Over-Year CPI and Projections

CPI and Progected CPI Year-Over-Year

Shelter is stabilizing factor that comprises a whopping 33.316% of the CPI. 

Owners' Equivalent Rent (OER) is the largest component with a 2020 weight of 24.26%. Rent of primary residence is another 7.86% for a total weight of 32.12%. 

Housing is not directly in the CPI and rents are pretty stable. 

Incremental increases in most of the CPI components plus a big increase in energy will lead to something like 3.4% year-over-year inflation in May by my calculations.

And if energy prices decline from here, in May of 2022 we will have year-over-year comparisons that will look more benign than they are. 

This is one of the problems with year-over-year comparisons when there is an unusual spike or dip.

Whether these year-over-year comparisons will “really spook the bond market” as Gundlach suggests remains to be seen.

If the market expects 4% or even 3.5% and the CPI comes in at 3.4% or lower, a huge bond rally could be in store.

Expect the Word Transitory

If these spike projections are accurate, expect Powell and other members of the Fed to be howling the word transitory for weeks on end. 

ISM Angle

This statement by Gundlach caught my eye.

Headline CPI could even go above 4% based on ISM data, which could trigger a bond selloff.

That is an angle I had not ever considered so let's put the thought to a test. 

ISM vs CPI

CPI Top vs ISM Bottom

I took the ISM portion of the chart from TradingEconomics and kept resizing the CPI chart from Fred via trial and error until the years on both charts aligned.

I highlighted negative correlations. There are about as many positive ones. . I see no relation between the ISM and CPI. The relationship appears to be totally random on average.

What about the Producer Price Index?

Healthcare is the Biggest PPI Component 

Healthcare, not energy is the biggest component of Producer Prices. And Producer Prices are not part of the CPI.

For discussion, please see Healthcare is the Biggest PPI Component With Over 3 Times Energy's Weight

Contrarian View

Now that the nearly everyone, but especially the average Joe, is looking for more inflation, the contrarian is looking the other way.

For discussion of the massive retail bet by small speculators on the inflation theme, please see my March 7 post Small Speculators Pile Into Treasury Shorts, Is a Short Squeeze Coming?

Also note my March 9 post Gold and Silver Pop as US Treasury Yields Drop

We are going to see a pop in year-over-year inflation, but then what? 

Inflation Largely in the Rear View Mirror

The Fed has blown another huge set of bubbles. Those looking for future inflation should instead look to the past.

We "have" inflation, and plenty of it. We will have it as long as asset bubbles keep inflation, but don't expect the CPI to follow except as pertains to easy year-over-year comparisons.

Factoring in housing prices, not just rent, inflation is already at 3.5% by my preferred measure, just not by the CPI.

For discussion, please see Fed Hubris: Housing Prices Show the Fed is Making the Same Inflation Mistake

With the real interest rate at -3.45% is it any wonder speculation in stocks, junk bonds, and housing are rampant? 

This is the same mistake the Fed made between 2002 and 2007 when it ignored a blooming housing bubble with dire consequences culminating in the Great Recession.

CPI Mistake

It is a mistake to continually believe monetary inflation will show up in the CPI.

It hasn't and likely won't any time soon because housing prices are not in the CPI and medical care is ridiculously undercounted due to people on Medicare and business coverage plans.

Pause in the Storm?

Previously I commented: Inflation Fears Recede After Another Tame CPI Report, Pause in the Storm?

I think not. Nor do I think there is a much of a storm to begin with. 

Before anyone of my readers scream, I am talking about inflation as measured not as really exists. 

It's easy to have "low inflation" when you don't count housing and undercount the cost of medical care

If you are looking for inflation, the last place to look is where they tell you to look

Looking ahead, I believe bubbles pop and the result will be anything but higher inflation.

Mish

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