00:00Well, facetiously, when I saw the core CPI come in flat, I thought, oh, Kevin Walsh was the most successful
00:05Fed chair ever.
00:06He's done it in a matter of weeks. He's solved for the inflation challenge in play.
00:11Except that, to your point, what we're seeing this month is entirely the energy drag explaining the headline decline.
00:18And there's enough going on in core CPI to tell us that these are probably some volatile components like motor
00:26vehicle insurance and wireless telephones.
00:28Those have dragged on core CPI. Underneath the surface, I am still concerned.
00:34And firstly, I don't know that we should be saying inflation is totally solved when core inflation in America is
00:40still at 2.6 percent.
00:41We are over five years of inflation above target, and we still have some pretty serious issues in the areas
00:49that matter most to consumers, like food, which is up 3 percent and still likely to accelerate ahead.
00:54And an extremely tight labor market that reminds me of the good old-fashioned demand-led inflation, which is still
01:01in the system as well.
01:03So I think two things can be true. We can celebrate that we've had some reprieve here this month in
01:07many areas of the report.
01:09This is good news for Chair Walsh as he heads into testimony, but it is too early to take our
01:15eye off the ball.
01:16Francis, would I get thrown out of the Federal Reserve if I walked in and said, you know what, in
01:21today's world order, 2.5 percent core CPI, that's fine.
01:25I mean, in a world where there's globalization is going by the highway here and it's all, you know, every
01:32man for himself, costs are going to be higher.
01:34That's just the way it is.
01:36What happens then?
01:39Would you get thrown out? No, but you'd probably be relegated to the basement with a few other colleagues who
01:43share the view, and you'd have to be really quiet about it.
01:46I suspect that the way we have to think about inflation now really comes down to this idea of what
01:53is supply-led inflation and what is demand-led inflation.
01:57And the San Francisco Fed actually breaks this out, and what they find right now is that it's about half
02:02supply given,
02:03and that's everything from AI to tariffs to the Strait of Hormuz coming through and created blockages, but half of
02:09it is demand-led.
02:10And this is the area that the Federal Reserve can control and should control.
02:16So while we continue to focus on these big structural trends that are meaningful to price levels and price growth,
02:22I think this Federal Reserve is really going to struggle more with the old-fashioned types of inflation.
02:27And that's because, Tom, if you've highlighted many times this morning, nominal growth is very strong in America.
02:33The labor market is extraordinarily tight.
02:36There is a massive infrastructure build coming out.
02:39It is the Gilded Age 2.0.
02:41And you have an exceptionally wealthy top 1% consumer.
02:46Those are the types of things that drive demand-led inflation.
02:50So the Fed can be excused, and all central banks globally can be excused for wanting to look through supply
02:57-led inflation that maybe brings us above 2%.
02:59But they have to stay focused on demand side.
03:03And that's where my concern in the second half of the year is, much more so than are we seeing
03:08energy coming up or down in a month-to-month.
03:11So I'm looking at the warp function here.
03:14Still looking for almost two rate hikes this year.
03:19Does that seem reasonable to you?
03:22We have the Fed on hold, and, of course, it's natural to say, OK, well, what does this number mean
03:27for the Fed?
03:28But I look at this number now from a different lens, which is what does this inflation mean for the
03:33consumer and tell us about the consumer?
03:36Because at the end of the day, what will matter for most businesses, for anyone picking stocks, for those who
03:42are trying to serve, is what is this telling us about the consumer?
03:45It's telling us that the consumer is not struggling under the same gasoline prices that they were last month.
03:52It's telling us there are certain items that they'll get some reprieve on, but it's still telling us that prices
03:59are too high for most consumers.
04:01And when you combine the CPI number with the fact that we no longer have tax refunds, that we have
04:06seen savings eroded, this is a consumer that may have had some reprieve now.
04:11But if we see another price shock in the second half of the year, whether energy prices rise again, whether
04:16food prices rise or reprieve, I don't believe this is a consumer that can withstand that, and you'll see pricing
04:21powers eroded.
04:22Francis, one final question.
04:24I think just to get us through the year and on into – I haven't said this yet.
04:302027?
04:31No.
04:32Are you ready for that?
04:33No.
04:33I mean, Francis, I look at all the uncertainties, all the different threads and narratives.
04:40Off your desk, is there a confidence to be in the markets given the economic confusion?
04:49It's not too early for 2027.
04:51We just had a meeting of when we were going to put out our 2027 outlook.
04:56It's July.
04:57And we have to contribute forecasts for 2027.
05:00And when we look into 2027, what we see is it is still really hard to bet against the American
05:06economy.
05:07And that is because of the structural support coming from non-residential builds.
05:11That's infrastructure.
05:13You still have a wealthy top consumer, and there's a lot of government money inside.
05:17There's productivity growth that is helping the American economy stay at or above 2% growth for the next 12
05:24to 18 months.
05:25And as we head into 2027, though, I think what will be the biggest challenge for markets to digest is
05:30that you're going to get what I'm calling fortuitous math,
05:32which is base effects are going to bring inflation in the second quarter down next year into as low as
05:371.3%.
05:39Core inflation will not be that low.
05:41It'll be in the mid to high twos.
05:43But we're going to have to digest some pretty serious base effects.
05:47But if you combine those two stories together, as I continue to say, it's real hard to bet against the
05:51U.S. economy.
05:52Francis, people are slowing down on I-80 right now across America.
05:56Do you know how much our listeners hate base effects?
06:00They go to the grocery store, and the base effect is, when did I pay $7 for oranges?
06:06They used to be $3.
06:08Or ambris.
06:09Prices are up 30% in five years.
06:13Consumers care way less about year over years.
06:16They don't care about what FedWarsha is going to do.
06:18They care about the real economy.
06:20And that's what numbers like this morning's CPI tell us.
06:23They tell us there's some short-term reprieve, but prices are too high,
06:27and consumers, the mass consumer, is still struggling under the weight of higher prices and the cost of living.
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