ANDREAS STENO LARSEN: Happy Friday, everyone and welcome to the Real Vision Daily Briefing. I'm Andreas Steno, sending live from Copenhagen, Denmark. To be honest, it's not a happy Friday for your portfolios out there unless you are short the markets. We've seen a lot of turbulence in markets after another high inflation print from the US. And to debate that exact inflation print, I'm joined by Peter Boockvar, the Chief Investment Officer of Bleakley Advisory Group today, welcome to the show, Peter and happy Friday.
PETER BOOCKVAR: Yeah, you too. Thanks for having me.
ANDREAS STENO LARSEN: Well, it was another shocker of an inflation report. We had a print of 8.6% if we look at the headline figure. Please unpack this shocking inflation figure for us.
PETER BOOCKVAR: And the core rate came in at six, the estimate was 8.9%. So, what's interesting about the headline number 8.6% relative to the estimate, this is the third month in a row with an 8-handle. And the comparison was tough. The May 2021 year-over-year increase in headline CPI was 5%. So, going up against that comparison, we were still able to print 8.6%, even though the core rate did moderate month-over-month, and came in, like I said, it's a 10th above.
Now, within the components, obviously, energy and food are driving the headline. But we're also seeing an undercounting in the rent calculation, which implies that if we're to more accurately measure the rental increases in the US, both new leases and also the rollover of an existing tenants lease, you're probably talking 10% inflation. The other thing that we have to keep our eye on, because obviously, we're going to look what's going to happen over the coming quarters rather than what already happened in May, is on the goods side, especially with the comments that we got from a bunch of retailers about the excessive inventories they have in some lines of their products, the goods that everyone loaded up on over the last couple of years.
So, on rate of change basis, core goods prices, which is about 20% of CPI is actually moderating, like I said on a rate of change basis, even though those prices are still very elevated. So, the question is how that rolls out over the next couple of months as these discounts taken effect, but then how much of this is offset by increases in other things on the goods side, and also the continued acceleration in services inflation, X energy.
ANDREAS STENO LARSEN: Yeah. We briefly spoke about this rent and shelter component before going on air. And it seems to me as if there is some kind of a lag effect from the real world and into the inflation index when it comes to shelter costs. Please take us through your thinking of how this component will develop over the coming quarters.
PETER BOOCKVAR: So, it is beginning to catch up. The owners' equivalent rents and rents on primary residence did show a 6/10 month-over-month increase, I think it was the second month in a row. So, those monthly gains that were 3/10, 4/10, 5/10 now has gotten to 6/10. So, obviously, we annualize that, and you're talking now year-over-year up to seven. Now, year-over-year, you're still in the mid-fives, so it still has more catching up to do, but at least we're on that right track.
The interesting thing about the rent component, it's obviously the BLS's way of capturing the housing component of inflation. Rents, even if the housing market moderates from here, you can still see this persistent increases in rents because it's too expensive to buy a home both on the purchase side in terms of price, and certainly on the funding side in terms of mortgage rates. So, there's still going to be this rather persistent demand for renting and keeping those increases going further higher.
Of course, also, you're having the shift in spending from a lot of the goods that are some are going to get marked down in price and acceleration in the prices of services like airlines, hotels, and restaurants.
ANDREAS STENO LARSEN: And let's remind the audience that the shelter component of the inflation index makes up around a third of the overall index and 40% if you look at the core index, so it is an important component for the Federal Reserve by the end of the day. I know that they track the PCE Price Index, and you have a point to make in terms of the housing costs related to the PCE Price Index.
PETER BOOCKVAR: Right. So, in the PCE methodology, they're a housing component, their shelters/rental component is half the percentage of CPI, so it dramatically undercounts that I think at a level that is below what the average renter spends on rent relative to their income. So, it's undercounting housing. Again, not just against CPI but against reality. And its biggest component, PCE, is health care at about double the percent that CPI is in.
And also, the difference between the health care methodologies and CPI and PCE is CPI is actually measuring out of pocket expenses, where PCE, its health care component is dominated by government price fixed Medicare, Medicaid reimbursement rates. So, that's why while PCE turns over its basket more often, I think that outsized contribution from those reimbursement rates with health care artificially suppresses it, and it is why it always has a deficit relative to CPI on a month-to-month basis.
ANDREAS STENO LARSEN: Yeah, very good points. And thanks for that explanation. If we look at the market reaction to this inflation report, we have the frontend of the dollar yield curve up by almost 25 basis points as far as I'm concerned by now. We have the dollar back in the driver's seat in the FX market, and we have equities down as a consequence of this report. What do you make of the repercussions for markets ahead of the interest rate meeting at the Federal Reserve next week after this report?
PETER BOOCKVAR: Well, as you mentioned, at least the change in Treasurys on the short end is that we brought back 100% chance in terms of pricing of another 50-basis point Fed increase in September. Just within the past week or two, that moderated to about 75% to 80%. And then also now in the July meeting, the market is now beginning to price in some odds that the Fed goes 75. So, I think that's why you have this outsized response in the 2Y.
Now, the 10Y initially rallied because you had a curve flattening right after the number hit as people priced in that 50 basis points in September, but then the whole yield curve fell apart. Well, I'm sorry, the yield curve continue to flatten, but the long end fell apart too. And we saw rates go up there as well. But also, that came in the context of another crappy day in European bonds, where you've seen a rather sharp increase in rates there.
And one thing that I've argued for a while is I hear too many people that are trying to predict where the long end of the Treasury curve will go just based on their growth and inflation analysis in the US. But if you're not paying attention to what's going on in European bonds, in the JGB market with growing pressure on the Bank of Japan, and also in Australia with the RBA bungling their monetary policy, we're all in this bond boat together, essentially.
And people have to scratch their head and say, well, US 10Y is at 315, just as we were all talking about the US economy, the global economy go into recession. And yes, inflation stats being high are an influence there. But again, I will argue that the air is coming out of this global bond bubble. And I think that is also a major driving force here in where rates are going.
ANDREAS STENO LARSEN: The European Central Bank presented its latest press release and press conference yesterday being a trigger for some of the moves that you mentioned in the European bond market, as well. And I think you're absolutely right to look at bond markets on a global scale. Because currently, it seems as if central banks are moving in tandem in the same direction towards tighter policies.
I know that you've been talking a lot about the word "fragmentation" when it comes to the Eurozone, and the monetary policy of the European Central Bank. What do you make of that word, "fragmentation"? And please also enlighten our audience on what you mean with that word.
PETER BOOCKVAR: So, I'm also going to tie that in with QE. QE in Japan, which was the author of it on a grand scale was, okay, let's suppress interest rates to encourage people to borrow. And then Ben Bernanke said, hey, that's such a great idea. Let's try it here. And part of that also was we need to buy a lot of mortgage-backed securities in late 2008 to save the banking system.
But the ECB took a different angle on their QE. Their QE was really more in response in 2011 was when the budgetary concerns started to really show itself in the periphery countries like Italy, Spain, Portugal, and obviously Greece, where Greece basically went bankrupt. And with the help of their lenders, were able to turn out their debt over 50 years plus. So, the ECB QE was more of a whatever it takes July 2, 2012 Mario Draghi approach to we need to salvage the Eurozone, and we are going to directly lower these bond yields.
That got to 5%, 6%, 7% in then we're overindebted countries now, even further overly indebted countries. Then that QE, so that QE really started out as financing government debts and deficits and budget deficits. And then Mario Draghi said, okay, well, we'll continue on, because we're worried about not achieving our 2% inflation target. And then of course, he went negative. So, here we are today, price stability is supposed to be their sole mandate but as I've said, what we've learned over the past 10 years is actually, it's their number two mandate, well down below their mandate of financing the debts and deficits of these peripheral countries.
And the fragmentation part is in response to Christine Lagarde who needs to satisfy the Germans and some other hawks on the committee to say, yeah, we're going to do with inflation, but then freaked out about what happens if we have another 2011 problem in Italy, Spain, Portugal in response to ending QE, and getting out of negative interest rates? So, by saying she's focused on the fragmentation is basically the Italian bond spread to the German 10Y.
And I say, the Italian BTP yield because Italy is the most overindebted country in the Eurozone, certainly on an absolute basis, and I'm putting aside Greece again because Greece has turned out a lot of their debts so I'm putting Greece aside, but Italy's debt to GDP ratio of 150%, which is above where it was just a couple of years ago. So, that spread has widened out to the biggest spread since May 2020 at about 225 basis points.
Now, it did get about 500 in 2011 so there's still a ways to go if you want to look at it that way. But she's worried about that spread blowing out. But then you wonder, okay, well, if you're ending QE, well, how are you going to prevent this fragmentation? That means you're going to reintroduce QE or are you going to use the maturing bonds to focus more on the periphery countries? They're in such a mess that this inflation story has created for them that I don't even know they know what they're doing at this point.
ANDREAS STENO LARSEN: I think that's a fair description. I tweeted yesterday that it was the most bipolar press release that I've ever read from a central bank, because they initially tell the audience that they will do whatever it takes to bring inflation back to 2%. That is the first sentence. And then they go on rambling about having to step into bond markets if spreads become too wide between Italian and German bonds, for example.
PETER BOOCKVAR: They're still going to do QE for another three weeks.
ANDREAS STENO LARSEN: Yeah. They won't end it until the first of July, which is almost amusing given that we have inflation running at above 16% in annualized terms if you look at the past three months in the Eurozone. One of the key culprits behind the inflation pressure, both in Europe, but also in the US, is energy. And I want to touch a bit upon that topic, because it seems to me as if energy prices is the focal point for the White House as well now. What do you make of the response that the Federal Reserve and the European Central Bank will have to make to these rising energy prices?
PETER BOOCKVAR: Well, it's so interesting, because up until a couple of years ago, or up until a year ago, all the central banks have wanted was higher prices to somehow equate to 2%. And when you think about an annual, and I'm going to get oil in a second, an average annual increase of inflation at 2%, that means that-- because we have some prices that go down every year. The price of a TV set is going to go down every year. The price of a laptop is going to go down every single year. That means you need other prices to go up to average out that too.
But any central banker will say, yeah, we want 2% but we just don't want oil prices to go up. Which is obviously inherently contradictory. So, now that we have all prices going up, in addition to oil, it obviously creates this problem. Now, it also creates a problem, because it heavily impacts psychology. When you think about what is the most in your face, daily reminder of prices? It's what a gallon of gasoline, at least in the US and how you guys denominate it in Europe, of a gasoline because a driver passes it every single day.
It's like the stock market. It's got its scoreboard every day. And a gas station has it scoreboard itself. And that's what people see every single day. So, that's what they start to see. That then obviously directly impacts their budget, but also impacts their psychology.
And when you think about monetary policy, monetary policy is solely meant to influence the demand side. Now, you can argue a couple of things. Through cheap money, it basically finance the US shale industry, so it is what enabled the US shale industry, or the US oil production get to 30 million barrels a day, because all you needed was land and a drill bit and somebody financed you, that was done for cheap money. So, again, so while monetary policy influences the demand through encouraging people to borrow, it also indirectly influences the supply side.
So, now you're in a situation where, okay, nothing is going to increase the supply side of oil at this point for a variety of ESG reasons and regulatory reasons and lack of pipeline reasons and so on. So, what is then central banks going to do? Try to destroy the demand side? I think that that is something that's impossible to control. And I think people should not understand that we are not just questioning what are the central bank's going to do next, we should be questioning their entire orthodoxy of trying to manipulate interest rates to get to a desired level of inflation.
If there's one thing that life teaches us is that it's very complicated. Human nature is very complicated. And what central banks have tried to do is treat us all like we're a video game, where if they press the right buttons on the computer, we're going to do certain things and get to their intended ended results. Well, life doesn't work that way. And I think that they're learning this firsthand that you can control things up to a point. And then once you lose control, well then things break loose and it's really difficult to bring that back into their fold.
ANDREAS STENO LARSEN: Yeah, and ultimately, when energy inflation is running wild, as it is currently, it becomes a political topic. And central bankers are in my humble opinion, by the end of the day, politicians so they will have to react to this.
I want to play a clip for you, Peter, from a conversation between Kyle Bass and Wil VanLoh, the founder and CEO of Quantum Energy partners from a discussion on the Real Vision platform earlier this week around this energy inflation debate. So, have a listen here.
WIL VANLOH: Everything that the average American uses is up anywhere from 50%, 60% to a couple of 100% the last couple years.
KYLE BASS: You're right, we're in a perfect storm. We had the disease that emanated out of China that took over the world, COVID. And our response from our central bank and the central banks of the world, was to flood the world with money. We printed 40% more money than was in existence before COVID. We had a monetary-- I'm a monetarist at heart. We had a monetary inflation.
But then now that's been coupled with a thoughtless or a lack of any true energy transition policy. And seven years of underinvestment or eight years of underinvestment now is leading us to a place where all of a sudden, we're getting above Arab Spring prices, and we haven't even seen next year's food costs yet.
Fertilizer prices have only doubled and tripled in the last 12 months, so next year's crop, it's going to be really expensive. There's this moment in time where the world's going to have a national security problem, because of one, too much money printing, but two, no energy policy.
WIL VANLOH: One of the things on food, and don't forget, Ukraine was a huge exporter of a number of different foods. They're one of the largest wheat producers and exporters in the world, so was Russia, by the way. There's just a whole another-- you look at the supply that's being taken off the market and that's going to I think even further exacerbate the issue of food prices.
ANDREAS STENO LARSEN: Yeah, energy inflation is certainly the hot topic. And as mentioned in the clip here, there is also a direct link between energy prices and food prices, which we basically experience across the board in Europe and the US now. Peter, it may be the stickiest part of inflation by the end of the day in this scenario, both food and energy prices, will it be tricky to get them down again?
PETER BOOCKVAR: Well, it'll be much more difficult to get energy prices down because of projects, investment projects are so-- they have such a long lead times, especially deep water, you got to have a 10-year-plus time horizon if you're going to make an investment in deep water. Shale, of course, the economics of that has changed. But these are multiyear projects.
The thing about agriculture is you have a better chance of curing the problem on the supply side. The demand side with agriculture is pretty consistent. As long as the global population increases, and as long as you have just a growing middle class around the world, the demand for food just going to go up every single year. It's always the supply side that really determines on the margin where agricultural prices go, food prices go.
Now in the US, we have one planting season in the spring, and you have your harvest in the fall. So, if there's a bad season, that leads