We're getting overbought here...
Paid subscriber analysis
After last week’s long-form analysis on interest rates (hope you enjoyed it!), this week we’re back to our standard short to medium-term market tracking.
We’ll talk about why the forthcoming period might present an opportunity for a pullback, more likely than over the past few months at least. We will be talking about the flows-related factors, but also keeping in mind political and general macro conditions.
On macro, we got two inflation prints this week: a slightly elevated CPI on Tuesday, and a more in-line PPI on Wednesday. To investors this signaled that we are starting to witness the first impacts of tariffs. You don’t see them on PPI numbers, because: " tariffs and taxes are not retained by producers as revenue, they are explicitly excluded from the PPI."
Send this to anyone claiming that a reduction in PPI is an example that tariffs did not impact inflation.
The truth is, tariffs are starting to show their effects on prices. Limited, but still showing.
You can see this better if you keep an eye on specific components, like this one:
The impact of tariffs is clearly visible in those sectors which are most exposed to tariffs, like household furnishing and supplies (upper chart, strongest growth since COVID). Similarly, recreation commodities - which contain things like video and audio products, are also showing a surge in prices due to tariffs.
Transportation products, on the other hand, are still showing no impact. This is still the sector to watch for the biggest effect down the line. Overall, impacts are not strong - yet. Why? Because neither of these categories represent a big share of the overall consumption basket. In other words, the consumers themselves are hardly noticing any impact. Hence the prevailing perception among the administration that tariffs won’t be inflationary.
Even bigger increases in prices might not affect consumers if they respond to higher prices by shifting their consumption to tariff-less substitutes. However, don’t forget how quickly inflation can spillover into other, seemingly non-affected sectors. We saw it all so well over the past few years. Hence the CPI report has shown that the Fed might be right in holding off cuts for now.
And then there is the political uncertainty element.
Best exemplified this week by Trump’s hasty proposal to Republicans on Wednesday that he is considering firing Fed Chair Powell, asking them whether he should go through with it. And then 20mins later saying he “isn’t planning on doing anything”.
The market reaction brought back those fond April memories:
But the key focus is still on tariffs and what’s about to happen come August 1st.
The markets right now are fully pricing in that Trump will back down on tariffs, offer another extension come end of July and/or implement them on a low 10-15% on key foreign trading partners.
If this does happen, the current valuations can indeed be justified, especially if they get combined with the fiscal stimulus from the Treasury in two weeks - talking, of course, about their decision to reduce long-term issuance, which we mentioned several times now. We will talk more about this next time, but for now, these elements: tariff reversal, Treasury stimulus, and possibly a quick decision on the next dovish Fed Chair, would all extend the current rally into September.
However, I do believe - at the moment - that a reversal is more likely before these elements all pool together.
Why?