The Fed's Dilemma - EconIntersect

by Jim Welsh

Macro Tides Monthly Report 02 April 2021

Operation Warp Speed

Operation Warp Speed was launched on May 15, 2020 with the goal to

“produce and deliver 300 million doses of safe and effective vaccines with the initial doses available by January 2021, as part of a broader strategy to accelerate the development, manufacturing, and distribution of COVID-19 vaccines, therapeutics, and diagnostics.”

Please share this article – Go to very top of page, right hand side, for social media buttons.

The announcement was initially criticized as being unrealistic, based on decades of experience in developing viral infection vaccines which normally require years or decades to assure the vaccine will not be toxic and have adequate efficacy. The fastest vaccine ever developed took four years to treat the Mumps in the 1960’s, so the notion that an effective and safe vaccine could be developed in less than 1 year seemed unrealistic as I noted in a number of letters. During an election year the goal looked more like political posturing and puffery. There was plenty of skepticism.

The June 6, 2020 issue of the medical journal Lancet opined that “on average, it takes 10 years to develop a vaccine. With the COVID-19 crisis looming, everyone is hoping that this time will be different. Although many infectious disease experts argue … even 18 months for a first vaccine is an incredibly aggressive schedule.”

On April 1, 2020 Dr. Anthony Fauci, director of the US National Institute of Allergy and Infectious Disease, said the earliest the US may get a coronavirus vaccine will be in 12 to 18 months.

In its May 28, 2020 edition, a Vanity Fair article entitled “You Cannot Do That: Why Trump’s ‘Warp Speed’ Race for a COVID-19 Vaccine Is Dangerous and Likely to Fail.”

On June 17, 2020 a CNN article proclaimed ‘Scientists worry ‘Operation Warp Speed’ is missing tried and true vaccines in favor of new and untested methods.

A New York Times article dated April 30, 2020 entitled ‘How Long Will a Vaccine Really Take?’: “Our record for developing an entirely new vaccine is at least four years – more time than the public or the economy can tolerate social-distancing orders.“

Health and Human Services secretary Alex Azar motivated his team tasked with the development of a vaccine with references to prior U.S. achievements:

“If we can develop an atomic bomb in 2.5 years and put a man on the moon in seven years, we can do this this year, in 2020.”

They initially dubbed their project “MP2,” for a second Manhattan Project, after the race to create the nuclear weapon that ended World War II, before changing it to Operation Warp Speed. The team decided to contract most of the vaccine supply for production before approval by the FDA. The U.S. agreed to buy 200 million doses each of the vaccines by Pfizer and Moderna, and 100 million doses from J&J. No one knew if any technology would be approved, so they wisely diversified and bet on several. It should be noted that European governments wouldn’t commit for doses of any vaccine until it was proven safe and effective. The willingness of the U.S. to take on the risk of investing in multiple technologies before they were approved is why three times as many Americans have been vaccinated compared to Europeans as of March 31, 2021.

The chart above illustrates the total number of vaccine doses administered per 100 people of the total population in the United Kingdom, United States, and European Union. The U.S. has vaccinated roughly 3 times as many people per 100 of the population as in Europe.

This is why the U.S. economy is on a faster path to reopening, while many countries in Europe are enforcing some level of lock down. The pace of vaccinations in Europe is also contributing to a third wave of COVID-19 cases, while cases in the U.S. decline.

On Dec. 11, 2020, the Food and Drug Administration (FDA) approved Pfizer’s vaccine for emergency use authorization and Moderna’s vaccine on December 18. The first person in the U.S. to be vaccinated was a Long Island New York ICU nurse on December 15, who later said:

“I trust science. What I don’t trust is getting Covid-19, because I don’t know how it will affect me and the people around me.”

Operation Warp Speed hoped to have 30 million vaccination shots administered by December 31, 2020 but less than 12 doses were distributed. The lack of clear distribution guidelines from the federal government and confusion and lack of preparation at the state and local government levels contributed to the slow start.

However, by the time Joe Biden was sworn into office on January 20, 2021 the U.S. administered 1.5 million that day and the 7 day average of vaccinations was over 990,000 and climbing rapidly. Improvements in distribution by guaranteeing the number of doses each location would receive so appointments could be scheduled, increases in manufacturing, and the establishment of large vaccination sites have helped the number of daily doses to reach 2.8 million as of March 30.

According to the Centers for Disease Control and Prevention data, more than 80% of those who have died in the U.S. from COVID-19 were older than 65. As of March 24 more than 70% of this age group had received at least one vaccine dose, and 44% were fully vaccinated. The elderly were also more likely to require hospitalization, so vaccinating this demographic magnifies the benefit of lowering future hospitalizations even if cases increase in coming weeks.

According to its website, FactCheck.org is

‘a nonpartisan, nonprofit “consumer advocate” for voters that aims to reduce the level of deception and confusion in U.S. politics. We monitor the factual accuracy of what is said by major U.S. political players in the form of TV ads, debates, speeches, interviews and news releases. Our goal is to apply the best practices of both journalism and scholarship, and to increase public knowledge and understanding.’

It wouldn’t be a surprise if during the Trump administration FactCheck.org needed to increase the amount of overtime its employees worked so they could verify or dispute claims and statements. But President Biden has also made a number of dubious and false claims regarding his Administrations COVID-19 performance.

As noted by FactCheck.org, President Biden made misleading claims while boasting about his administration’s progress in getting Americans vaccinated against COVID-19 in remarks at a Pfizer manufacturing site on February 23. President Biden claimed that the Trump administration had “failed to order enough vaccines.” In fact, the Trump administration had contracts in place for plenty of vaccines for all Americans. In December 2020, Pfizer and Moderna had agreed to provide 400 million doses (200 million each) by the end of July, according to a Government Accountability Office report.

President Biden also said:

“We’ve made it possible for you to get a vaccine at nearly any one of 10,000 pharmacies across the country, just like you get your flu shot.”

According to FactCheck.org he is taking too much credit. On Sept. 16, the Trump administration announced a COVID-19 vaccination distribution plan developed by the Centers for Disease Control and Prevention for distributing future vaccines. The CDC said it would use retail pharmacies to administer vaccines to the general population. As of Oct. 29, 2020, 12 major retail chains with over 35,000 store locations “have signed on to participate.”

President Biden promised that 100 million doses of vaccine would be administered in the first 100 days of his administration. President Biden is happy to remind everyone that this goal was achieved on day 58, but reminds me of the movie ‘The Sting’ which is set in the 1930’s. The mark (target of the sting) places a big bet on a horse race that has already finished. Needless to say he loses, duped by the ‘con’.

The U.S. had administered 16.2 million doses prior to and 1.5 million doses on January 20, according to the Centers for Disease Control and Prevention’s 5 COVID Data Tracker. Joe Biden was inaugurated on January 20. As the chart of the 7-day average shows the rate of increase in vaccinations prior to January 20 was steep and virtually guaranteed that the goal of 100 million doses would be achieved easily.

On March 25 President Biden increased the goal to 200 million within 100 days which should count as a layup during March Madness. The 7-day average on March 25 was up to 2.5 million doses and more than 130 million shots had been delivered. President Trump often boasted the economy was the best ever, even though growth averaged just 2.5% in the three years prior to the Pandemic. Excluding 2009 GDP grew an average of 2.2% in the last seven years of President Obama’s tenure, averaged 3.88% when Clinton was President, and 3.48% under President Reagan.

A little over a year ago the U.S. and global economy was shutdown and by April more than 20 million American workers were out of work and millions of small businesses were on the brink of going out of business. The notion that 150 million vaccinations would have been administered by the March 31, 2021 would have seemed preposterous. As the Organization of Economic Cooperation and Development (OECD) stated:

“The rapid development of effective COVID-19 vaccines is an extraordinary achievement.”

Let’s not allow politics to minimize what Operation Warp Speed accomplished.

GDP Growth to Zoom on Vaccinations and Stimulus

Millions of American workers have learned how to Zoom in the past year which has introduced Zooming to just about everyone. Families have utilized Zoom to replace in-person gatherings to celebrate birthdays and holidays. This technology can’t replace getting a hug from a family member or a fried but it certainly made the past year more bearable. My wife’s monthly Book Club hasn’t missed a month since March 2020 as everyone tunes in using Zoom. Soon everyone over the age of 60 will be vaccinated and by September 80% of everyone over 15 will be.

With the availability of vaccines becoming widespread for just about everyone by the end of April, and stories of bad reactions virtually non-existent, more people are becoming comfortable with getting vaccinated and getting back to ‘normal’. Within the next 5 months more than 80% of people surveyed by Civic Science said they would be ready to go shopping and 77% said they would be willing to eat inside a restaurant.

Although there is reluctance to go on a vacation in the next month, more than 70% feel they will be ready to travel and go on a vacation within 5 months. As noted in the March Macro Tides:

“Travel and lodging represents less than 3.0% of GDP, Restaurants and Bars generate less than 5% of GDP, Arts i.e. movies, concerts, theatres comprise less than 5% of GDP, while Hair Salons and Barbershops account for 0.25%. The sectors that have been hit the hardest represent a relatively small proportion of GDP compared to the sectors that have held up well or actually benefited from the Pandemic.”

Although the hardest hit sectors represent less than 15% of GDP, they could easily surge by 30% or more in coming months and add more than 4% to GDP growth. Estimates for GDP in 2021 are at best educated guesses, but Capital Economics thinks growth could reach 7.0%. If correct, 2021 may match the fastest growth in the past 50 years when GDP reached 7.24% in 1984 and above the second highest level of 6.5% in 1966.

The surge in 2021 is the result of a record amount of deficit spending.

In 1966 the deficit was only -0.5% of GDP, -4.6% in 1984 after President Reagan lowered taxes and ramped up defense spending, but will exceed -10.0% in 2021 despite near historic growth. In 2020 Europe provided more fiscal support than either the U.S. or Japan to boost growth. In 2021 the increase in fiscal stimulus by the U.S. dwarfs what the Euro Area and Japan have done to date.

Of the $5.2 trillion in fiscal stimulus, $870 billion (17%) went directly to households in the form of distributions ($1200 checks followed by $600 and $1400 checks). These distributions more than replaced the lost income from unemployment and reduced hours worked.

Many consumers used the funds received to increase savings and lower credit card balances by more than $115 billion, which has made debt payments as a percent of disposable income more manageable.

The initial disbursement of $1200 went to married couples earning up to $198,000 so most of the funds went to families that didn’t need it. A large survey of recipients for the National Bureau of Economic Research found that only about 15% of people surveyed report that they mostly spent their payment, while most respondents said they saved the payment or used it to pay down debt.

The majority of people receiving the stimulus checks were not adversely affected by the Pandemic. They were still working and, since they couldn’t go out to a restaurant, movie, or take a vacation, they were already able to save more and pay off debt.

The threshold for receiving the subsequent $600 and $1400 distributions was lowered to $150,000 for married couples in the second and third stimulus packages. When compared to the first distribution of $1200, the breakdown of how much was spent was probably less, with more money used for savings and debt reduction. As such a sizable portion of the $870 billion in direct payments did not spur economic growth and to some extent widened the income and wealth gap between those families with less than $50,000 of income and more likely to have been unemployed, and those families with incomes well above $100,000. There is a touch of political irony in that those who were most in favor of the recent $1.9 trillion COVID Relief Bill are the most vocal critics of income and wealth inequality.

Christine Romer was the Chair of the Council of Economic Advisers in the Obama administration. On March 25 she published an analysis of how fiscal policy was used to address the Pandemic, entitled “The Fiscal Policy Response to the Pandemic“.

This table is from her summary and the link to her entire analysis is provided in the Related Links section.

“”Overall, the fiscal response to the pandemic in the United States runs the gamut from highly useful and appropriate to largely ineffective and wasteful. Spending on programs such as unemployment compensation and public health was exactly what was called for by the unique nature of the pandemic recession. Spending on broadbased payments and other general stimulus measures was much less useful in a recession where the impacts were highly unequal and the Keynesian multiplier was likely substantially reduced by lockdowns. …
If something like the $1 trillion spent on stimulus payments that did little to help those most affected by the pandemic ends up precluding spending $1 trillion on infrastructure or climate change in the next few years, the United States will have made a very bad bargain indeed.”

The U.S. economy is poised for a significant jump in economic activity which will be accompanied by a spurt in inflation that will test the Federal Reserve’s new policy framework.

The Fed Will Be Tested

Without a whole lot of fanfare the Federal Open Market Committee has made a significant change in how the Federal Reserve will conduct monetary policy going forward.

The Phillips curve is named after economist A.W. Phillips, who examined U.K. unemployment and wages from 1861-1957. Phillips found an inverse relationship between the level of unemployment and the rate of change in wages. As slack in the labor market fell as measured by the unemployment rate wages began to grow faster, company’s increased prices and inflation rose. In the U.S. the relationship between the unemployment rate and the lagged increase in the Personal Consumption Expenditures (PCE) index was fairly tight in the 1950’s, 1960’s, 1970’s, and 1980’s.

However beginning in the 1990’s and since, the PCE didn’t rise much, even though the unemployment rate fell to historically low levels. The expansion after the financial crisis was the longest in U.S. history and by 2019 the unemployment rate was the lowest in 50 years. Based on the Phillips curve the PCE should have gone up but it remained muted. The breakdown in the relationship between the unemployment rate and the PCE brought about the demise of the Phillips Curve, and the Fed’s willingness to allow it to guide monetary policy.

The FOMC will no longer increase rates based on projections of higher inflation but instead will wait until inflation materializes, even though this approach increases the risk that the Fed could fall behind the inflation curve. Inflation is going to increase noticeably in coming months but the FOMC has a plan. Like repeating a mantra, Powell and other members of the FOMC will say this wave of inflation will be temporary so there is no need for the FOMC to overreact by lowering the $120 billion in monthly QE purchases of Treasury bonds and Mortgage Backed Securities or increasing the federal funds rate.

The FOMC believes their forward guidance is a powerful weapon of communication that will in this case keep the bond market from freaking out. As Mike Tyson said

‘Everyone has a plan until they get punched in the mouth.’

The Fed’s dilemma is that the coming surge in inflation could prompt the Treasury market to punch the FOMC members in the mouth. If the punch is strong enough (much higher Treasury yields), the FOMC could be forced to blink (reduce monthly purchases, raise the federal funds rate), or choose to continue to repeat their mantra like a bunch of meditating monks.

Even if the FOMC members choose to look through the coming wave of inflation and not react to a spike in Treasury yields, the increase in yields will negatively impact the interest sensitive sectors of the economy (i.e. housing). Higher Treasury yields will compress the stocks sporting high P/E ratios as has already occurred. If yields increase enough, a meaningful correction in the cyclical stocks would surely follow.

In February the Fed’s favorite inflation metric – the Core Personal Consumption Expenditure Index (PCE) – rose by a modest 1.4% from February 2020 and well below the Fed’s inflation target of 2.0%. The Core PCE has rarely been above 2.0% since 1997, even after the FOMC formally adopted its 2.0% target in 2012. The FOMC now projects it will rise to 2.2% in 2021, and then dip to 2.0% in 2022 and be 2.1% in 2023. The February inflation data for the Core PCE and Consumer Price Index (CPI) may prove to be the last benign inflation data for many months.

Consumer Price Index Set to Jump

Most people pay far more attention to the headline Consumer Price Index (CPI) than the Core PCE, since that’s what they pay when they go to the grocery store, get a tank of gas, and go out to eat in a restaurant, take in a movie, or go on a vacation. The sectors that have been most severely impacted by the Pandemic are likely to raise prices as demand increases to make up for some of the lost revenue when they were effectively shut down. Cheap air fares are going to be hard to find (airfares may rise 14% by June according to Hopper), hotels won’t be offering as many low cost ‘Get Away’ packages, movie ticket prices will be increased, and restaurants won’t have as many special meal discounts.

The next 6 months are likely to prove a challenge for the FOMC since there numerous inputs that are going to push the headline CPI above 3.0% and maybe close to 3.5%. The headline CPI includes food and energy (blue line) which are fairly volatile and why the FOMC chose to focus on core inflation. Large rallies and declines in crude oil and gasoline prices have contributed to big swings in headline CPI inflation, well above and below the Core CPI (red line).

Headline inflation soared above 5.0% in 2008 as WTI oil prices rocketed to $147 a barrel and then plunged to -2.0% in 2009 after crude prices dropped to $33.20 in February 2009. By May 2011 WTI crude had recovered to $114.00 a barrel only to collapse from January 2014 through February 2016 when WTI hit $26.05. After a market dislocation caused WTI oil to fall to $-40.00 on April 20, 2020 it was $10.00 a barrel on April 28, and has since rallied to above $60.00.

Gasoline prices are correlated with WTI. According to Gas Buddy, the average price for regular gasoline has risen to $2.86 a gallon as of March 29 from $1.74 in March 2020, an increase of 64%.

The Bureau of Labor Statistics calculates the Consumer Price Index and gives gasoline a weighting of 3.36% within the CPI. Based on its weighting and the 64% increase in national gas prices, the headline CPI could be lifted by 2.1% just from the increase in gas prices. The CPI for March will be released on April 13. In July 2020 National gas prices had recovered to $2.20 a gallon, so gasoline’s contribution to the CPI will fall to about 1.0%, if gas prices hold near $2.86 a gallon through June.

Food prices have also been ratcheting higher. The United Nations Food Price Index has jumped by more than 25% in the past year as grain prices soared.

As noted in the February Macro Tides:

“Soybean, corn, and wheat prices have soared in recent months with soybeans and corn up 68% since last August and wheat ahead by 39%. The increase in grain prices will continue to feed into many consumer foods, which will push up the cost of food at home and in restaurants by more than the 3.9% in the past year.”

Excluding energy and gold, 86% of commodities have produced a positive return over the past year, which is the highest percent since September 2011. The CPI peaked in September 2011 at 3.9%, and the extreme in positive returns now suggests the inflation push from grains and raw material prices could peak in coming months.

The regional surveys of business activity in Federal Reserve districts show that 66.8% of manufacturing firms surveyed reported paying higher prices for their purchases. This is just below the level reached in 2008 and only slightly higher than the peak in 2011. Only 30.9% of the firms reported raising their prices, so the majority of firms will be working hard to lower other costs or allow profit margins to narrow. Compared to 2011 more firms are increasing their prices, as illustrated by Prices Received (blue line).

Supply Chain Woes

One factor that could extend the price pressures facing many manufacturers and businesses that rely on imports is the disruptions to supply chains, which wasn’t a factor in 2011 or in 2008 when prices were rising. U.S. ports are struggling to handle the volume of containers coming from overseas. Los Angeles handled 799,315 containers overall in February, up 47% from a year 12 ago, and is projecting more than 830,000 containers to pass through its docks in total in March and April. The Port of Long Beach moved 771,135 containers in February, up 43.9%, the port’s largest-ever annual increase.

The huge increase in off loading containers has unmasked another supply chain issue. There is a shortage of truck drivers and warehousing outside the port needed to handle the volumes. The Los Angeles port considers itself at full capacity when it has 80% of its space filled with containers waiting to be transported, but was at 90% of capacity in early March.

Regional Federal Reserve surveys in February and March found that Supply Chain disruptions were wide spread and severe. The percent of firms reporting a disruption ranged from 61% in Dallas to 85% in Kansas City. These disruptions are pressuring price increases but also causing a reduction in manufacturing output. The automobile industry has been directly impacted.

A modern car typically has about 100 microprocessors controlling everything from fuel intake to windscreen wipers. Computers are used in so many ways from the basic trip monitor, road scanning active suspension, providing a warning if the car drifts out of its lane, to remembering how different drivers like their seat positioned. Microprocessors have made cars quicker, safer, cleaner, more efficient, and more reliable.

According to a Deloitte analysis, electronics are responsible for 40% of a new car’s total cost, up from 18% in 2000.

Microprocessors have become indispensible to the automakers but they have also become an integral part of just about everything consumers use every day. Microprocessors are in smart phones, washing machines, microwave ovens, dish washers, refrigerators, smart televisions, DVD players, and even hair dryers. The widespread dependency on microprocessors for so many products has led to a computer chip shortage.

Working from home has fueled a boom in computing services and the data centers behind them, which is straining chip availability and leading to higher prices. Computer chip makers and auto manufacturers don’t expect the situation to normalize until at least the second half of the year, with some analysts expecting the chip shortages lasting into next year.

The chip shortage caused the global auto industry to produce nearly 700,000 fewer cars than they had planned for the first quarter, according to research group IHS Markit Ltd. Auto makers furloughed tens of thousands of workers in the first quarter. GM expanded the downtime at plants in Kansas, Canada and Mexico to mid-March, and said it expected lost production from the chip shortage to lower profits by $1.5 billion to $2 billion this year. Ford has cut back production of the F-150 pick-up and estimates the chip shortage could lower vehicle output by 20% in the first quarter. Honda adjusted production, with most North American plants running at reduced output. The decline in car and truck production will dent GDP growth in the first quarter but also weigh on growth in the second quarter, until the chip shortage is over.

At the end of February, dealers had 2.7 million vehicles in stock, a 26% drop from the same month last year, according to Wards Intelligence. Dealers had about 414,000 pickup trucks at the end of February, roughly half the number from a year earlier. Many auto makers have curtailed the deep discounts they offered early in the pandemic. Car companies on average spent about $3,562 per vehicle on discounts and other sales incentives in February, a $600 drop from the same month a year earlier, according to research firm J.D. Power. For car and truck buyers this means they are paying $600 more for their new vehicle.

With the supply of new cars and pickup trucks down, more new vehicle buyers are choosing instead to buy a used car. The Manheim Index for Wholesale used vehicle prices applies statistical analysis to its database of more than 5 million used vehicle transactions annually. The Manheim Index for Wholesale used vehicles was up 23.7% in mid March from March 2020. The increase was led by a surge of 43.1% for pickup trucks, 20.4% for luxury cars, 19.0% for SUV’s, and 17.6% for vans.

Import Prices Reverse Higher

After peaking in the fourth quarter of 2011, import prices have subtracted from inflation for most of the past decade. The peak in 2011 aligned with a high in grain and manufacturing prices and changes in the Dollar, which has an inverse correlation with import prices. After bottoming 14 in 2011 the Dollar surged into 2015, which caused import prices to be negative from 2012 to 2017. The Dollar topped in March 2020 and lost about 10% of its value until it bottomed in January 2021.

Import prices have responded to the Dollar’s weakness in 2020 rising to 3.0% in early 2021 and the highest level since 2011. There is a bit of lag between changes in the Dollar’s value and import prices, so the weakness in 2020 should continue to lift import prices in the first half of 2021. The Dollar has bounced about 3% from its low in January 2021, which should put a lid on rising import prices in the second half of 2021, unless the Dollar slumps again.

Rising import prices from China has been one of the drivers behind the increase in import prices in general. In the last year prices for imports from China are up +1.2% and the steep trajectory suggests it will take several months before price increases decelerate and then roll over.

Just One Word: Plastics

The deep freeze that overwhelmed most of Texas in mid February has had lasting affects for the chemical industry. The weather turned so cold so quickly that the majority of manufacturers didn’t have time to properly shut their plants down, compared to hurricane warnings which usually provide a sufficient lead time. As a result pipes were frozen with polymers inside causing damaged that will take time to clean thoroughly and get production up and running.

This time delay matters since almost 85% of the polyethylene made in the U.S. is produced in Texas. Polyvinyl Chloride (PVC) is one of the most widely used polymers in the world, and can be found in window frames, drainage pipe, water service pipe, medical devices, blood storage bags, cable and wire insulation, resilient flooring, roofing membranes, automotive interiors and seat coverings, fashion and footwear, packaging, credit cards, vinyl records, synthetic leather and 15 other coated fabrics.

Prices for polymers more than doubled within days as 75% of production was shut down. The large price increase will work its way through the supply chain until production is back to normal which is still weeks away.

Commodity Prices Are Nearing a Peak

As noted, 86% of commodities excluding energy and gold have produced a positive return over the past year, which is the highest percent since September 2011. According to the Commodity Futures Trading Commission (CFTC), speculators have amassed the largest long position in 17 different commodities since 1996. This indicates that a lot of money is s already positioned to benefit from what is being billed as the Next Commodity Super Cycle.

China accounts for as much as 60% of the world’s resource consumption, and during the past year went on a spending spree. Historically there has been a pretty tight correlation between commodity prices and China’s Credit Impulse.

In 2011 regional Federal Reserve indexes of prices paid topped, the CPI peaked in September, food prices stopped going up, and Import prices crested. All of these important indications of inflation ran out of gas after China’s Credit Impulse (CCI) peaked in early 2011. As the CCI fell into lat 2012, all of these measurements of inflation retreated. A secondary and lower high in inflation was established after the CCI topped in 2014. The CCI and commodities in general sold off into early 2016, with crude oil falling from $114.00 a barrel to under $27.00 a barrel. Commodity prices and inflation were able to hold up in 2018 despite the weakness in the CCI as markets responded to President Trump’s large tax cut and synchronized global growth.

The CCI began to rise in early 2020 (did China know what was coming?) and received a big boost after every Central Bank and Advanced Economy responded with fiscal stimulus. The increase in commodity prices represents pipeline inflation, which will show up in the CPI in coming months. It is noteworthy that the CCI has rolled over even as commodity prices have 16 continued to climb in February creating a large gap between the CCI and the Bloomberg Commodity Index.

During March a number of high flying commodities have dipped with nickel prices down by -18%, copper by -9%, and cobalt off by -13%. The CCI continued to fall once it reversed in 2011, 2014, and 2017, and we’ll see if this pattern holds in 2021.

Copper inventories have jumped from 200 tons to 380 tons in the past two months, which could be another sign that China has reduced its purchases. If the CCI continues to decline it could signaling an easing in inflationary pressures and commodity prices during the second half of 2021.

As discussed in the January 2021 Macro Tides, I thought the Bloomberg Commodity Index ETF (DJP) would at least rally to $23.10 and might get up to $25.80. DJP traded up to $25.10 on February 24 and has since pulled back. As long as DJP holds above $23.00 it is likely to exceed $25.10 and could rally to $25.50 – $25.80, before a more significant correction ($21.00?) develops in the second half of this year.

Will the FOMC Stand Up to the Heat?

By indicating that the FOMC will not lower their monthly QE purchases or increase the federal funds rate no matter how high inflation flies or GDP soars, the FOMC has drawn a line in the sand at the worst possible time. In the next few months many factors are going to combine to make it look like a serious bout of inflation is beginning. Get ready to read plenty of articles that say that inflation has finally reared its Ugly Head and that the FOMC is already behind the curve. Gold Bugs will be hyperventilating about the coming wave of HYPER INFLATION with 17 references to the post World War I Weimar Republic and workers needing a wheel barrow of money just to buy a loaf of bread.

In may take some time but most of the factors that are contributing to the coming surge in inflation will gradually ease after mid-year. Oil prices have more than doubled since bottoming in April 2020 enabling gas prices to rise by more than 60%. On April 1 the Organization of the Petroleum Exporting Countries (OPEC) agreed to gradually increase their output over the next three months. OPEC crude producers have been holding back roughly 8 million barrels per day, but will increase its output by 350,000 barrels per day in May and June, and roughly 440,000 barrels per day in July. Oil prices may not decline much, but are more likely not to rise as much as summer time driving boosts demand.

A good portion of supply chain bottlenecks are likely to dissolve as ports catch up and vaccinated workers return to work so production of many products increase. As supply chains issues are resolved, the current price pressures in the pipeline will recede. The computer chip shortage is likely to take longer which will weigh on economic growth.

As discussed in the March Macro Tides the strength in housing will diminish in the second half of 2021. Fewer people will move out of cities or choose to buy a larger home in 2021 as more employees return to office work for at least part of the workweek. Home prices are getting more disconnected from average incomes and the gap is larger now than in 2006.

Higher mortgage rates are raising the monthly payment, so housing affordability is falling which means fewer people can buy a home. The largest factor that will continue to weigh on Existing Home sales is the record low level of inventory. As home sales moderate so will the demand for furniture, carpeting, and every appliance many new home owners purchase after moving in, so the housing slowdown will ripple through the economy.

The Dollar has firmed up so the increase in import prices will peak and fade. If demand for commodities from China softens further, the prices of grains, industrial metals, and oil will decline in the second half of 2021. Even if Congress passes the American Jobs Plan (i.e. Infrastructure Bill) by Speaker Pelosi’s July 18 timetable, very little of the money will be spent in 2021. Calling it an Infrastructure bill is a bit disingenuous since a significant portion of the spending has little to do with infrastructure.

Chair Powell has repeatedly claimed that the coming increase in inflation is likely to be temporary as he noted in this response to a question about the chip shortage during his March 23 appearance before Congress:

“There will be a little bit slower growth and maybe some modest upward pressure on prices. But that should be something that is temporary. You know, a bottleneck by definition is temporary as the supply side adjusts.”

Chair Powell will likely be proven correct, but in the next few months many factors are going to contribute to a more intense increase in inflation than expected. The majority of FOMC members are likely to hold the line, unless the Core PCE rises above the FOMC’s median forecast of 2.4% in 2021 and appears headed higher. If the Core PCE does move up to near 2.4%, the FOMC’s credibility could be on the line and reluctance to respond would only feed the narrative that the FOMC is behind the curve. This scenario could increase concerns that the FOMC could be forced to move more aggressively through balance sheet tapering and earlier rate hikes as it tries to play catch up.

As part of its Forward Guidance policy the FOMC will want to communicate months in advance any changes in its balance sheet, as any change in the federal funds rate will come after tapering. With inflation ramping higher and job growth increasing robustly in the next few months, speculation will mount as to when the FOMC will signal it’s considering tapering its $120 billion in monthly purchases. Knowing this market participants will front run the FOMC. Conjecture about the initial tapering hint will first focus on the July 28 FOMC meeting, and really ramp up prior to the meeting on September 22.

The Treasury bond market has just experienced its worst quarter in decades and sentiment has reached a negative extreme. The price pattern in the 10-year and 30-year Treasury yield suggests they can drop by -0.25% or so in the next two months, before rising to a higher high in the second half of the year.

The equity market is likely to be supported by good economic news in the short run, but buffeted by the prospect of a less accommodative FOMC in the second half of 2021 and the prospects of higher taxes.

Gold, silver, and gold stocks may get a big lift in the next few months, as inflation jumps and the FOMC says no changes to policy are forthcoming.

Fauci said it will take 12 to 18 months to get a coronavirus vaccine in the US. Experts say a quick approval could be risky. (Business Insider)

“You Cannot Do That”: Why Trump’s “Warp Speed” Race for a COVID-19 Vaccine Is Dangerous and Likely to Fail (Vanity Fair)

Scientists worry ‘Operation Warp Speed’ is missing tried and true vaccines (CNN)

The crash landing of ‘Operation Warp Speed’ (Politico)

Biden’s Misleading Vaccine Boasts (FactCheck)

The Covid-19 Vaccine Effort Is Protecting Older People, Growing Evidence Suggests (WSJ)

FactChecking Biden’s Prime-Time Address (FactCheck)

US Budget Deficit by Year Compared to GDP, Debt Increase, and Events (The Balance)

How Did U.S. Consumers Use Their Stimulus Payments? (NBER)

The Fiscal Policy Response to the Pandemic (Brookings)

Shipping Logjams Spread on Crush of Imports (WSJ)