Following last week’s inflation report from The Bank of England this week’s actual inflation report for July came in much as expected with the headline CPI dropping to 3.1% Y/Y from 3.2% in June.
Because of my recent foray into the media about inflation and the economy I have been paying closer attention to UK inflation and the underlying factors driving it. What no-one seems to notice, or care about, except for the B of E is that CPIY i.e. inflation without indirect taxes and in particular without VAT fell from 1.6% Y/Y to 1.4%.
This is the measure we should focus on as the VAT decrease in 2009 followed by the increase in 2010, which will be followed by anther increase in 2011 will make it impossible for anyone to deduct anything from the headline CPI number - anyone who says differently is either stupid or lying, or both!
This was also the case in 2009 when CPI was much lower than CPI-Y as the effect of the temporary VAT reduction fed through to CPI. What is more interesting is that CPI-Y has continued to fall from the peak of just over 5% in 2008 to the current level of 1.4%, albeit not in a straight line, the trend is clear......lower!
Even the inflationists favorite measure the RPI, when stripping out the VAT effects etc and looking at the RPIY fell from 3.8% Y/Y to 3.5%.
Elsewhere it is deflation that's staring policy makers in the face - The Fed is clearly worried and it probably won't be long before QE2 light will be replaced by a fully fledged version somewhere between $500 billion and $1 trillion. Philly Fed's survey which was released yesterday at -7 instead of the expected +7 and weekly jobless claims topping 500k again.
Recovery? Has it been and gone already?
In the bond markets yields are reflecting the very weak economic backdrop (even if the equity market participants are not fully embracing this reality) and with US mortgage yields in deep re-financing territory (all the ones who can will refinance) the negative convexity is playing havoc with duration i.e. If you need/want duration the only place to go really is the back end of the yield curve, which is why it’s starting to flatten smartly and will probably continue to do so as 2 year yields below 50 bp’s hardly provides any protection or yield, 30 years at 3.60-something is the place to be. 10-30’s is still north of 100 bp’s and that could easily come back into the 50-75 bp range during the remainder of this year. It could go even lower depending on the launch of the new QE2 and the scope/weighting of it.
All the bond-bubble alarmists will be hurting emotionally (financially as well if they put their money where there mouths are) as the market will continue to rally and the curve continues to flatten......but the more of them there are the better for the market’s prospects as short covering is a very powerful thing.....!
If you care for a more thorough trashing of the latest bond-bubble alarmists' arguments then you should read David Rosenberg's daily comment from yesterday.....it's very good reading indeed!
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