This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday
Good morning from New York. I’m Kate Duguid and when I’m not filling in for Rob and Ethan, I write about Treasuries at the Financial Times.
We have some meaty topics to get into today, like the latest inflation data and the debate about whether the dollar still has a place at the centre of the global monetary system. Dollar dominance is one of those topics that comes up every few years — people get worked up and then it all dies down and nothing changes.
I’ve been a victim myself: when China set up a crude futures exchange denominated in renminbi a few years ago, an analyst fully convinced me that a global petroyuan system was upon us. Now that you know I’m gullible, send me emails at kate.duguid@ft.com.
Shelter costs may finally be coming down
US monthly consumer price data released yesterday showed the first real signs of a slowdown in shelter costs, a promising development for Fed chair Jay Powell and anyone worried about persistent inflation.
Shelter costs are part of the services category of CPI and include rent and something called owners’ equivalent rent — a funny metric that estimates how much a property owner would have to pay in rent for it to be equivalent to their cost of ownership. The shelter category has been among the biggest drivers of inflation for months — and it still is. Yesterday’s report cited it specifically as “by far the largest contributor” to the overall figure, more than offsetting the big decline in the energy index.
But shelter costs slowed in March. The shelter index rose by 0.6 per cent month over month, down from 0.8 per cent in February and the lowest level since November. It’s not much of an improvement — and the yearly rate of 8.2 per cent is very far from the Fed’s average target of 2 per cent — but it’s notable because shelter costs have remained high even as other costs have moderated.
The Fed’s aggressive interest rate increases have helped ease inflationary pressures in lots of areas of the economy, while bugbears like energy and used cars have been helped by unsnarled supply chains and a warm European winter.
The neat interactive chart below made by my FT colleague Sam Learner lets you see progress on the various components of CPI at different rates. Of interest to us here is the shelter category versus all items, on a month-over-month basis.
But the shelter index has remained stubbornly high because there is a big lag in the data, so improvements in the real economy are slow to feed through to CPI. Idanna Appio, a portfolio manager at First Eagle Investments, said the lag tends to be about 15-18 months. Data from private companies such as Zillow shows that rental cost increases began to slow just over a year ago, putting us on track for some easing in CPI. You can see that peak in the Zillow data in the charts below.
None of these developments are necessarily enough to sway the Fed’s hand at its meeting in May. “Shelter is losing momentum. That is definitely welcome news for the Fed and for financial markets,” said Torsten Sløk, the chief economist at Apollo Global Management. But, he said, “There is still a long way for the shelter component to go.”
That reflects the current view of the futures market, where investors are pricing in a 0.25 percentage point interest rate increase in May, though they do see cuts coming towards the end of the year.
Appio said there are three tests before a pause in rate increases is justified: a drop in core goods, a drop in shelter inflation and a drop in core services excluding shelter. The Fed has done the first and has now made some progress on the second. The third — which reflects prices on everything from medical services to transportation — remains extremely high. It is also tightly linked to wages and the strength of the labour market, so it could be a deterrent to rate cuts if the level does not come down.
You’re the yuan that I want
The dollar’s position at the centre of the global monetary system has been hotly debated — and largely uncontested — for decades. A series of energy deals priced in yuan has raised the issue again.
China has clearly been working to increase the use of yuan in energy transactions globally. A deal with Brazil in March means that transactions between the two countries will be priced in yuan and reals, avoiding the dollar; The Wall Street Journal reported that Saudi Arabia is considering pricing some oil sales in yuan; and France just did its first LNG deal in the Chinese currency. And during Xi Jinping’s visit to Moscow last month, Vladimir Putin said he would use yuan for payments between Russia and other countries.
Our FT colleague Gillian Tett has written really well on the topic recently here.
While the share of dollars held by global central banks has shrunk in recent years as they have diversified their holdings, there’s no evidence broadly that the dollar is being displaced.
But David Kelly, the chief global strategist at JPMorgan, earlier this week published a very interesting note arguing that there is a threat to dollar dominance at the moment — but it’s coming from inside the house.
From inside the House, more specifically. “Investors should, however, be aware of the risks posed to the dollar by the current stand-off in Washington concerning the debt ceiling.”
The US Congress is engaged in its periodic, very American battle over the debt ceiling. The US needs to raise its debt limit to pay its bills, but the procedure by which that is approved has been hijacked, with Democrats and Republicans attempting to use the threat of default as leverage to win political victories.
Individual taxes are due on April 18 here in the US, and once those are in, the government will have a better idea of how much longer it can continue functioning before it runs out of money. You’ll remember that in 2011, US debt was actually downgraded, though that ultimately had few repercussions. Another downgrade would be much more consequential.
Kelly says: “Any miscalculation in this regard could be catastrophic, undermining faith in the credit of the US federal government that has been accumulated since the days of Alexander Hamilton. If such an event were to occur, it would likely add a permanent risk premium to US government bonds and precipitate a much sharper decline in the dollar. It would also add a powerful argument to the arsenal of those promoting other global currencies who could then point to the US democratic process as a source of economic vulnerability rather than economic strength.”
One good read
The latest JPMorgan Epstein revelations.
