Inflation Suprise, Positions Unwound.

Macro Perspectives

The August inflation numbers came in a little higher yesterday morning.

But did a 0.1% monthly increase in prices justify a 4% decline in stocks on the day? That's 1.1% annualized inflation.

Maybe it was the uptick in the inflation number after extracting the effects of food and energy prices (i.e. core prices)? But that number disrupted a trend of declining core prices since March. And if we look at a couple of the "hot" components of core CPI, new car prices and rents (which have put upward pressure on the "shelter" component), there are reasons to believe the slowdown in those prices are coming, just lagging (given falling used car and home prices).

Bottom line, this is a big deal for markets, to the extent that market positioning was leaning heavily in the direction of expecting a positive surprise in this August inflation report. We got a slightly negative surprise. Positions unwound.

With that, let's take a look at the chart on stocks ...

As you can see, with yesterday's decline, stocks gave back nearly all of the gains from last Wednesday - the downtrend on the year remains intact and so does the low from June.

Let's talk about that low. The June bottom in stocks was marked by the European Central Bank's flip flop on bond buying (i.e. quantitative easing, QE). Just weeks after the ECB announced they would end QE, they had to restart QE - to backstop the sovereign bond markets of the fiscally fragile eurozone countries (QE by a new name, the "Transmission Protection Instrument").

Two days later, the Bank of Japan doubled down on their bond buying program (holding the line on their ultra-easy policy and unlimited QE via their yield curve control strategy).

So the Fed was raising rates and beginning quantitative tightening (extracting liquidity) back in June, which created shock waves in global markets. But the shock waves were quickly absorbed as two major central banks dug in - positioning to defend global markets from shocks (i.e. QE). That was the bottom for stocks…and that still holds.

If there's one thing we've learned from the events of the past decade, it's that global central banks will do, in coordination, "whatever it takes" to preserve stability.

Risk ON | OFF 1 year (trailing) returns shown below.