The Quant Brief●

The Investor's Edge

The argument this letter has been making all week finished on Thursday. Every maturity on the Treasury curve closed at a 52-week high, and the front end moved hardest: the reported two-year rose 14 basis points to 4.567% and the three-year 14.5 to 4.666%, against 8.1 basis points at the thirty-year. Our own measured marks on the prior session were 4.43% at the two-year and 4.83% at the ten — the cited 4.954% ten-year sits twelve basis points above the measured Sep-09 reading, which is a fair indication of how fast this moved. The two numbers that matter most are ours. The measured 2s10s spread FLATTENED for a third consecutive session to 0.39%, and the measured five-year breakeven jumped five basis points to a fresh high of 2.46% with the ten-year breakeven at 2.40%. Higher expected inflation with a flatter curve is not a market looking through a supply shock. It is a market pricing the committee's answer to one, and the five-year breakeven now sits six basis points ABOVE the ten-year, which locates the expected inflation in the near term rather than the far.

The impulse got worse and it is now measurable in the official data. West Texas Intermediate settled at $102.48, up 6.7% — the largest single-session move of the episode — and Brent futures at $107.63, up 5.9%, with oil at its highest since May; our measured spot marks are $97.26 for WTI and $109.50 for Brent on the Sep-09 session, the latter above the futures settlement because a steeply backwardated market pays a premium for barrels today. August producer prices, measured at 5.4% year on year against 4.8% in July, are the first official measurement of the pass-through; the monthly figure matched consensus exactly at +0.4% and July was revised up from unchanged to +0.1%. The control experiment sits in the same section: measured Henry Hub natural gas FELL to $2.81, because American gas has no exposure to the Strait of Hormuz. What is being priced is not generalised commodity inflation. It is the pass-through of one geopolitical price into everything that has to be moved.

The equity tape took a fourth consecutive decline and produced no winners at all. Six measured gauges on the Sep-10 session: financials −0.47%, energy −0.51%, technology −0.56%, the S&P 500 −0.58%, small caps −1.04% and semiconductors −2.75%. Energy had risen on the previous two sessions and stopped; chips, the longest-duration cash flows in the index, fell five times as far as the market. From the measured Sep-03 close of 7,747.71 the S&P 500 has given back 156.01 points, or 2.0%, in four orderly sessions with no day worse than six tenths. One of the week's three incompatible forecasts finally moved: the volatility index closed at a cited 17.89, up 8.69%, against our measured 16.46 Sep-09 mark. Credit did not move at all — measured high yield at 2.71%, investment grade unchanged at 0.81%, and the Baa spread actually TIGHTER at 1.55%. And the assets sold as inflation protection all fell: measured gold at $4,391.90 and silver at $64.48 on today's mark, bitcoin down 2.09%. That is what happens when compensation rises because the central bank is expected to ACT, because then the real yield rises too — the measured ten-year real yield went to 2.46%.

Which makes the next four hours the position. August CPI lands at 8:30 with consensus at +0.4% on the headline and 3.4% year on year, and +0.2% on core with 2.4% year on year; the Wall Street Journal's survey of seventeen economists has a median core of 0.22% inside a range of 0.16% to 0.24%. Governor Waller has said he would vote to hold at 0.2% and support an increase above it, so the entire decision sits inside the width of that survey. Futures have moved between 62% and 72% on a September increase in three days and sit near 70% this morning; UBS has withdrawn its advice to lock in yields and now forecasts increases in September and December to a 4.00-4.25% range. The committee decides at 2:00 p.m. on Wednesday inside a blackout that runs to the 17th, so the market prices this print across a weekend with no official able to damp it. Three practical conclusions: read the core line before the headline and the shelter component before either; note that the assets which protect against this particular inflation are the ones that pay a coupon, not the ones that do not; and size for the fact that four orderly sessions have not yet produced a single forced seller.