US inflation upswing remains in place even as the Federal Reserve says it’s transitory and announced a only a gradual reduction of QE. This means the Fed will only slow the purchase of Treasury Securities, with the balance sheet continuing to grow until ~June 2022. Despite the Fed dismissing inflation risks, the key indicators followed by The Dispatch continue to accelerate. The all-important shelter index (See Dispatch #23) continues upwards, plus we now have signs of wage inflation. We continue to be positioned for higher inflation and negative real rates in client portfolios.
In digital assets, the President’s Working Group on Financial Markets(PWG) released a much-anticipated report on stablecoins. Lengthy TLDR: Congress should pass laws to regulate stablecoins. In the absence of Congressional action, the Financial Stability Oversight Council should address the risks raised in the report. This includes imposing capital requirements and FDIC insurance for stablecoin issuers. Some in Congress are already pushing back on the report. Ultimately, government is NOT banning stablecoins or crypto; they are asking Congress to pass laws to regulate the sector. Is this not another signpost of digital asset acceptance?
The full list of discussion subjects of The Dispatch #36, completed on November 5th, 2021, follows.
- Inflation upswing remains, despite Fed’s transitory narrative
- Port backlog can’t be solved quickly – a Trucker’s view
- The push for stablecoin regulation
- Thailand’s largest bank buys crypto exchange for $1.04bn
- Morgan Stanley publish crypto primer
- Mayors of New York City and Miami take bitcoin salary
US inflation upswing remains despite Fed’s transitory narrative
The Fed announced this week that they will ease the current $120bn per month asset purchase by $15bn per month starting in November. If that pace is maintained, Fed balance sheet will stop growing by June 2022. The size of the Fed’s asset holdings have more than doubled since Covid to ~$8tn.
Ending QE slowly over eight months points to limited concern for higher inflation. Yes, the indicators that The Dispatch follows paint a worrying picture. In Dispatch #23, we surmised that rising shelter (rents) inflation will keep inflation high. The shelter index rose 3.2% YoY in September, up sharply from the 2.8% YoY reported in August.
CPI Shelter Index continues to rise
With Shelter index starting to rise, it’s mathematically tough for CPI to ease in the coming year because shelter is 1/3rd weight of the CPI index. The chart below illustrates the divergent path of home prices and shelter cost since Covid. We anticipate the gap narrowing in the coming 12-24 months despite a structurally underreporting of shelter inflation.
A longer-term chart of the shelter inflation index illustrates how the introduction of Owner Equivalent Rent around 1987 has led to lower shelter inflation. There are many adjustments that government authorities make calculating inflation. The overly complicated and opaque shelter cost formula is possibly the largest source of suppressed prices.
There are plenty of large national rental cost estimates. Reports by Apartment List and Zillow show double digit rental cost growth. Zillow’s Observed Rent Index rose 12.9% YoY nationally in September. Apartment List saw national rents surge 16.4% from January to October 2021. In contrast, the Department of Labor says the shelter index was up 3.2% YoY. There’s a lot of catching up to do.
Source: Apartment List to Oct’21
Wage inflation joining the party
Even more worrying is rising wage inflation. In 3Q21, the wage cost index grew at the highest rate over the past two decades, as the chart below shows.
Many mainstream economists continue to suggest that the wage hikes are one-off as this WSJ article elaborates. It’s still puzzling why the economics profession suggests that we shouldn’t care about one-off jump in prices. It is a gut punch when inflation takes a 5-6% chunk out of real purchasing power. Compound that trend for several years and a savings nest egg can be materially impaired.
Inflection point in labor dynamics
Workers are quitting jobs at a record pace. In August 2021, the Labor Department reported 10.4m job openings vs. 8.4m unemployed looking for work. This WSJ article explain how a jump in retirees during Covid is one driver of the tightness.
With tightening labor markets, unions are becoming more aggressive. Workers went on strike at John Deere and extracted inflation adjustments for wages and a higher increase. Lyft and Uber prices remain elevated due to a lack of drivers, even after pandemic unemployment assistance ended. 3Q21 unit labor cost rose at an 8.3% annualized rate, a sharp jump from the 1.1% pace in the June quarter. There are plenty of concerning data points, as you can see.
Markets are pricing in several rate hikes in 2022
Mr. Markets is taking note and pricing in rate hikes in 2022, which is far from the Fed’s guidance. The Dispatch is puzzled by lower long-term rates because we see inflation staying high for longer. Long-term rates are dropping because rate hikes will crimp economic growth, goes the current narrative. We think the markets will have to tackle the issue of worsening real rates due to inflation before it worries about GDP growth beyond 2022. We remain comfortable with our inflation-protected tilt.
Port backlogs can’t be solved quickly, says this trucker
Staying on the subject of inflation, this Medium post provides an insider’s eye-opening take on the current supply bottlenecks. It’s another reason to believe that inflation will remain high for an extended period. After reading the post, it’s clear to this writer that the cause of the bottleneck is the structure of truckers’ contracts/income.
Yes, there are many other contributing factors, but our reliance on road transport means the trucking shortage is the epicenter. This WSJ article also highlights the poor economics for truck drivers. However, in our outsourced world, low truckers’ wages mean record trucking company profits. The US has an estimated 3.5m truck drivers. This sounds like another profession that should and will see much needed wage adjustments.
Pandemic-induced surge in goods demand will normalize
Let’s be clear, though, that supply chain-induced price rises will be transitory because goods demand will normalize, helping ease bottlenecks. On November 3rd, the White House released this study on supply chains, which The Dispatch appreciates. We doubt Main Street will understand or care that surging goods demand is leading to inflation.
This imbalance will normalize and we are already seeing signs. The sharply lower sales at Peloton is a good example. More such announcements should be a sign that excess demand for physical goods is ending. If this didn’t normalize, and we added higher wage and shelter inflation, we could have a worrying surge in inflation. That’s not The Dispatch’s base case.
Government push for stablecoin regulation
The President’s Working Group (PWG) released a 23-page report on stablecoins that calls on Congress to pass legislation to regulate the asset class. The report also suggests that the Financial Stability Oversight Council address risks raised in the report, if Congress doesn’t act. This includes imposing capital requirements and FDIC insurance for stablecoin issuers. This report essentially suggests that all centralized stablecoin issuers need to be banks. Today, there is not a single crypto firm that has a banking charter. Circle, the issuer of the 2nd largest stablecoin USDC, has announced it will seek a banking license. Circle CEO Jeremy Allaire converted a tweet thread into a blog post, which provides an insider’s take on the report.
It does an excellent job of parsing many of the points made in the report and showcasing some incorrect and difficult assumptions made by the report. Parts of the post shown here highlight both the positive and the negative.
Congress is pushing back
It’s also good to see that some in Congress understand this emerging asset class and are pushing back. Here are a few tweets from Tom Emmer, who is leading the push, along with Congressman Juan Soto of Florida, for crypto legislation. Here’s their bipartisan legislation proposed back in August to provide clarity to digital assets.
Ultimately, government is NOT banning stablecoin or crypto! They are asking Congress to pass laws to regulate the sector, which is how it should be. This report is a sign of broader public acceptance of digital assets. It’s another de-risking of the asset class from a glass half-full viewpoint.
Thailand’s largest bank buys crypto exchange valued at $1.05bn
While many Western countries are attempting to tamp down digital assets via regulatory mandates, here’s an example of both a company and country boldly moving into crypto assets. Emerging market firms don’t have the institutional baggage of calling bitcoin a ponzi scheme for years. As a result, Western banks, we imagine, find it tougher to pivot to investing in the rapidly growing digital asset sector. This deal still needs to pass regulatory approval in Thailand. These two stories in the Bangkok Post and Coindesk provide a modest amount of additional information.
Morgan Stanley publishes crypto assets research
Speaking of global banks investing in “ponzi” assets, Morgan Stanley released a 60-page Crypto Primer this week, which is quite good. It is far superior to the mostly traditional stock coverage focused effort from Bank of America that Dispatch #32 highlighted. Here’s evidence that traditional finance can quickly pivot to an emerging asset and execute well.
Mayors of New York and Miami to take bitcoin salary
Eric Adams is the incoming mayor of New York City and Francis Suarez is already mayor of Miami. We’ll let the tweet below speak for itself!
Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
| This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results. |