Joe McAlinden
January 20, 2017
MRP Chairman, Ex-CIO Morgan Stanley Investment Management, Ex-President Argus Research

U.S. CPI Gets a Two-Handle... Bearish for the Dollar

 

Yesterday's release of the December consumer price  index showed a monthly gain that didn't seem like much, but it is quite  significant from a big picture perspective. The 0.3% jump brought the  year-on-year change up to 2.1% from the 1.7% that it had hit the month  before. Since September of 2015, the U.S. CPI inflation rate has jumped  by over 200 basis points. In the meantime, the U.S. Federal Reserve has  raised the Fed Funds target rate two times by one quarter point each  time -- in other words,  inflation has risen four times more than interest rates. Inflation-adjusted rates have actually fallen by over 150 basis points !

MRP  has long argued that, while changes in the nominal interest rates of  one country compared to another tend to get all the media attention as  it pertains to exchange rates, it is the inflation-adjusted short-term  rates that matters. For that reason, we have had the non-consensus view  that the U.S. dollar, rather than strengthening further in the year  ahead, is likely to weaken. According to a Bank of America survey, "Long  the U.S. dollar" is by far the most crowded trade in money management.

The  plunge in real rates will only get worse as the year-over-year percent  jump in energy prices filters through the numbers in January and  February. What analysts would call easy comparisons if they were looking  at a company's earnings will be a huge factor in boosting CPI numbers  even further; in the absence of an unexpected extra tightening by the  Fed, real rates will only drop further into negative territory. As a  result, the dollar is likely to come under additional pressure. 

A falling  dollar would reinforce our bullish position on gold and gold miners. It  won't hurt oil stocks either. However, it is likely to be an additional  negative for the long-duration segment of the fixed income markets.



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