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Fed Gets the Inflation It Wanted, But Wait There’s More!

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The Federal budget deficit is shrinking as the economy experiences an inflationary boom. This is just what the Fed was hoping for, but inflation has obviously gotten away from them. It will only get worse as the lagging rent component of CPI will push the total index higher, even if and when the other components begin to moderate.

The rent of shelter and owner’s equivalent rent that’s based on it make up about 40% of Core CPI. Those two components are not based on real time market rents. They’re based on a survey of renters, asking them what they’re paying. The OER is derived from that as a base, and then adjusted from time to time by asking homeowners how much they thought their houses would rent for… As if they knew.

This isn’t merely a dumbass way to measure rent inflation, it’s fraud. Contract rents are usually adjusted upward at a rate far below the increase in market rent. That’s because landlords like to keep good tenants in place rather than incur the friction costs of raising the rent too much and having them leave. It costs money to find a new tenant, and spruce up the unit.

So when the BLS asks tenants what they’re paying, it does not get the full effect of the currently soaring rents. Apartment List does a national rent report showing rents up 17.8% year over year. BLS has imputed the rent component of CPI at 4.1%. At 40% of core, this difference means that the BLS is understating total Core CPI by roughly 5.5 percentage points. That’s obscene. It’s an affront to human intelligence.

But CPI was never intended to measure inflation. That’s why they took home prices out of the index in 1982. CPI was always intended as a tool for indexing government wages and benefits, and industrial labor contracts. In the 1970s indexing got too expensive as home prices surged. So they worked out a way to remove house prices and falsify the housing component of CPI beginning in ‘82.

Now, the Fed is devaluing the mountain of debt out there. Bond holders will get a small fraction of their purchasing power back if they hold to maturity. And if they don’t, and sell along the way they’ll get killed on the capital loss as a result of collapsing bond prices.

We saw this coming since about a month after the bond market turned in August 2020. I don’t think it will get better any time soon, although certainly there will be bond rallies from time to time. Still consistent with my message of the past 18 months, they’ll be xxxx xxxxx (subscriber version).

Meanwhile, the budget deficit will narrow as long as the economy booms. That will reduce Treasury supply. But it won’t reduce it to $20 billion a month. Maybe it will fall to an average of $60 billion per month as some forecasts suggest. Maybe it won’t. I don’t know. The economy is booming at the moment, and there’s no reason yet to expect a slowdown.

But it doesn’t matter. Because the market has shown that it can only absorb $20 billion per month while the Fed kept bond prices stable and suppressed by buying or funding $180-$200 billion per month in net new supply.

Now, if the Fed isn’t buying, and the market can only absorb $20 billion per month, with supply even as low as $60 billion, that’s $40 billion in excess supply that the market can’t take at a stable bond price.

Therefore, bond prices will xxxx xxxxx (subscriber version) and so will stocks, as they get xxxx xxxxx . They’ll be xxxx xxx xxxxxxxx xxxxxxxxx on leveraged funds who hold both stocks and fixed income. And they’ll get xxxx xxxxx because eventually rising yields will force some money managers to xxxx xxx xxxx xxxxx.

There will be no xxxx xxx xxxxx, except to xxxx xxxxx (subscriber version). I’ll continue to look for xxx xxxx trading opportunities in the Technical Trader reports. I’ll leave xxx xxxx the bond market to whale hedge fund professionals.

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