Slippery slopes

Macro Man is back from his little ski trip, suitably chastened by the knowledge that the soon-to-be 14 year old Macro Boy the Elder is now the fastest skier in the family.  It seems as if it was just yesterday that your author was guiding his firstborn down the gentlest of Alpine slopes in a snowplow; now he's getting over-taken at speeds of 90 km/h, according to Skitracks.   That's too fast for Macro Man these days, particularly given the pair of ACL scars that he's sporting; when he asked his son how he managed to go so fast, the lad replied, "when I saw you go ahead of me, I just pointed down the mountain and quit turning."

The analogue to trading and investment could not be more obvious.   Those of us with the age, experience, and yes, scars of previous cycles may take it a bit more cautiously than some youthful Icarus who has yet to have the 'daredevil" chip uninstalled, but at least we generally make it down the proverbial mountain in one piece.  Every cycle has its "obvious" investment theme that comes a-cropper, and it's useful to have the experience of navigating down slippery slopes when they do.   This time around, it's looking like nothing less than the ability of monetary authorities to direct asset prices in the desired direction that may have taken a nasty spill on an icy mountain.

Macro Man was intrigued to see the relatively muted reaction to Friday's CPI data.  While it was perhaps notable that the headline annual inflation figure crept back above zero, the real story was of course in the core figure, which registered its largest monthly rise since May of 2006, which coincidentally enough was just around the time that the previous tightening cycle ended.  If one didn't know any better, one might think that core CPI was beginning to accelerate higher!

If the Fed targeted core CPI, this might be a big deal; alas, they've chosen the core PCE price index as their target, and that's barely moved.  Even before this latest CPI figure, the differences between the two measures was unusually large; the December 2015 spread of 0.68% was the largest since 2002, save for three months of similar magnitude in 2009.  What's interesting is that if the spread were at its average level of the last two decades (0.37%), we'd be looking at a core PCE inflation rate of 1.8% that nearly rounded to 1.9%.  With the unemployment rate where it is, it would difficult to see the Fed managing a single paltry rate hike (which is actually more than currently priced into markets) if the core PCE was printing at such a level with a similar trend.

What's particularly intriguing is that medical care showed a large rise in the CPI  figures, jumping 0.7% m/m and 3% y/y.   Readers may recall that one of the big discrepancies between the CPI and PCE measures is the weighting of health care, which comprises 8% of the former and some 20% of the latter.   If the PCE measure of health care cost were to register a similar jump, well then things could get very interesting indeed.  All the more so because health care inflation (or lack thereof) is one of the reasons that the PCE measure is so much lower than the CPI measure:

The PCE data is released on Friday.  Obviously, there's a lot of time between now and then for the equity market to do whatever it wants, but with Fed funds effective at 0.38% and January '17 Fed funds futures pricing a rate of 0.53%, that ( along with white eurodollars) looks like a very low-risk short going into this number in a few days.

Moving across the pond, talk in the UK is understandably about the Brexit issue.  The summit deal probably went about as expected; Cameron wrested a few concessions out of Europe and cemented the UK's unique place in the union, but these measures were never going to appease hard-core Euro-skeptics.

What's interesting is the free reign that the PM has given the cabinet and other prominent Tories to vote their conscience, and how quickly a couple of them, most notably Boris Johnson, have come out in favour of leaving the EU.

Mr. Johnson, for the uninitiated America reader, is essentially the antithesis of Donald Trump.  He is a long-time politician with chalky-white skin who doesn't take himself particularly seriously, cares not a whit for the state of his hair, travels to work by bicycle, and rather than making patently spurious claims about his physical fitness, puts his lack of athletic prowess on public display.  In other words, he's a clown, but people generally like him, he's held prominent posts (Mayor of London), and his voice will have some impact in shaping public opinion.

Although sterling has fallen fairly sharply at the time of writing, taking a step back it may be fair to ask why.   As noted above, the summit was largely within the bounds of probable outcomes, and while the date for the referendum was formally announced for June 23, we were always going to get a date for that sooner or later.  Perhaps it's a reaction to the dissent within the Tory party, though at this juncture it's early days in terms of judging the efficacy of the campaigns on public opinion.

There is still much that is unknown, including what Britain's relationship with the EU would be in the event of departure.  A comprehensive free trade agreement, for example, would mitigate much of the fear of the impact of a departure on Britain's economy, but who knows what the timing would be, or whether some latter-day de Gaulle would try to put a spanner in the works.

Ultimately, that is the reason why we're likely to see a risk premium continue to get built into sterling: not because of what we know about a Brexit, but because of what we don't know.  Once it starts falling down that slippery slope, it might prove rather difficult to climb back up.

Note:  If you are an email subscriber who's found that you've not received the emails recently, it may be the case that they are going directly to the spam folder (Gmail seems to be particularly bad in this regard.)  Simply click on 'not spam' and you should be good to go henceforth.