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Fed Still Has An Inflation Problem Despite Plunging Oil Prices
The FOMC’s policy stance is determined by the balance of risks to its dual mandate of price stability and full employment. In the current environment, those risks remain firmly skewed toward inflation, justifying last week's FOMC pivot from an easing bias to a tightening one. Today's plethora of May economic data shows that the economy and the labor market are in great shape, while both headline and core PCED inflation rates rose further above the Fed's 2.0% target (chart) . June's plunge in oil prices will certainly reduce the headline inflation rate, but the core rate is now up to 3.4% y/y. Before the war, it was stuck just below 3.0%. In his press conference last week, Fed Chair Kevin Warsh acknowledged that inflation has exceeded the FOMC's target for more than five years and committed the Fed to restoring price stability. Accordingly, we remain inclined to expect at least one rate hike before year-end, with July a live possibility. Falling energy prices may slow core inflation. However, the AI spending boom is driving up electricity bills and consumer electronics prices. Today, Apple announced significant price increases because of soaring memory chip prices. The Cleveland Fed's Inflation Nowcasting projects that June's headline inflation fell to 3.9%, while the core inflation rate remained stuck at 3.4%. Let's have a closer look at today's inflation report and economic indicators: (1) Inflation. Headline PCED inflation surged to 4.1% y/y in May, the highest since April 2023. Core PCED also spiked to 3.4%, its highest since October 2023. Goods inflation was 4.8%, led by a 5.6% increase in nondurable goods (chart). The latter should moderate quickly if the recent plunge in oil prices sticks. Durable goods inflation remained elevated at 3.3%, suggesting that the effect of last year's tariff hikes hasn't fully abated yet. Housing services inflation edged up to 3.2% y/y (chart). More importantly, services excluding energy and housing inflation rose to 3.9% y/y, the highest since September 2023. This so-called "supercore" inflation rate is a key measure of underlying inflation. It is well above the Fed's 2.0% inflation target. (2) Consumer Spending. The consumer remains in good shape despite rising inflation. Real consumer spending rose 2.1% y/y to a new record high in May (chart). Real disposable income posted its first monthly gain since January 2026. But it has been basically flat for the past year. We attribute this to the retirement of Baby Boomers, who collectively have a record $89 trillion in net worth and are using it to fund their spending now that they don't have paychecks. May's saving rate held at 3.0%, the lowest since 2022 (chart). We expect it will continue to fall as more Baby Boomers retire. The advance in real consumer spending during May was broad-based, reflecting healthy underlying demand across many categories (chart). Interestingly, higher gasoline prices did reduce consumers' gasoline usage, but didn't reduce spending in other categories during the month, with the exception of food services & accommodation and transportation services. These should rebound now that gasoline prices are falling. Meanwhile, capital spending remained very strong in May, as new orders for nondefense capital goods, excluding civilian aircraft, jumped to yet another record high (chart). (3) Labor Market. The labor market continues to show signs of improvement. Initial jobless claims fell to 215,000 during the week of June 19, confirming that layoff activity remains remarkably subdued. Continuing claims are also low (chart). (4) GDP. Q1-2026 real GDP growth was revised up to 2.1% from 1.6%, driven by a downward revision to import growth from 21.1% to 11.8% (chart). Consumer spending growth, however, was revised down to 0.5% from 1.4%, largely due to adverse weather weighing on Q1 activity. The Weekly Economic Index moderated to 2.5% for the week of June 19 (chart). This is consistent with the latest update to the Atlanta Fed's GDPNow model. The Q2-2026 real GDP growth estimate was revised down from 3.1% to 2.5%, reflecting downward revisions to real consumption growth from 2.8% to 2.0%, while business equipment spending was revised up from 13.8% to 14.% (chart). Both point to stronger consumer spending and robust capital investment, supported by AI infrastructure spending, during Q2.
On SpaceX, Google & Tesla's Patent Filing
Shortly after its IPO, SpaceX now has sold a $25 billion bond offering, with no shortage of takers. Today, Jackie examines the reasons that the company, after racking up major losses last year, was granted investment-grade ratings on the new debt. … Also: Alphabet has recently been on a losing streak in the stock market and so has the Communication Services sector broadly. Multiple factors have weighed both down, including a drop in Alphabet’s prospective 2027 growth owing to its huge Q1-2026 MTM accounting gain. Will the stock’s DJIA inclusion reverse its bad luck? … And: Tesla has filed for a new patent on what sounds like a mobile, modular AI data center, the Megapod.
Is The Dollar Debasement Trade Kaput?
The "Dollar Debasement Trade" was a big theme in global financial markets last year. The thesis was that President Donald Trump's aggressive tariff hikes would revive inflation in the US and undermine foreigners' confidence in the US's reliability, especially among America's allies. In addition, the president's attacks on Fed Chair Jerome Powell threatened the Fed's independence and heightened concerns that a compliant Fed would keep rates artificially low to finance widening federal budget deficits. In this scenario, foreign investors would respond by selling the US dollar and US securities in favor of foreign currencies and securities, gold, Bitcoin, commodities, and other non-US assets. The result would be a bad combination of rising US Treasury bond yields, falling US equity prices, and a weaker dollar. Following Trump's Liberation Day tariffs on April 2, 2025, and his attacks on the Fed, that scenario briefly materialized, with the dollar falling, equities declining, and yields rising.We were rightly skeptical about this so-called "Sell America Trade." As tariff concerns eased and recession fears abated, the debasement narrative lost momentum. Its credibility might have ended last Wednesday, when Fed Chair Kevin Warsh made price stability his top priority at his first FOMC monetary policy meeting. Traders rapidly priced in two rate hikes by early 2027, bolstering the dollar.Consider the following developments suggesting that the debasement trade is kaput. (1) Currencies. The dollar index (DXY) found support at the lower end of its rising channel since last year (chart). It has strengthened since last week's FOMC meeting. DXY is a fixed-weighted basket of the US dollar against six major foreign currencies, with the euro and yen having the largest weights at 57.6% and 13.6%, respectively. The euro has been weak in recent days, even though the ECB raised its official rate by 25bps on June 11 (chart). The recent decline in energy costs should benefit Europe more than the US, yet the euro has still fallen since last week. The BOJ also raised its official rate by 25bps on June 16, yet the yen just dropped back to levels not seen since December 1986 (chart) (2) Gold & Bitcoin. The Fed's new tightening bias and the recently rising dollar have weighed heavily on the gold price. After a record-breaking run to a new high of $5,589 per ounce on January 28, the price of gold began to fall when the latest Middle East war began at the end of February (chart). Some central banks reportedly were forced to sell their gold reserves to defend their weakening currencies. The subsequent hawkish Fed recalibration under Warsh increased the cost of holding gold. We think it has found support at $4,000. If that doesn't hold, the next level of support is around $3,500. We are reducing our year-end forecast from $ 5,500 to $ 5,000. After peaking above $120,000 on a series of crypto-friendly catalysts late last year, Bitcoin has been cut in half to $60,990 (chart). It certainly doesn't pose a serious threat to the US dollar. (3) Commodities. Brent crude plunged following the reopening of the Strait of Hormuz, which returned supply to the market and unwound much of the geopolitical risk premium (chart). Previously, we observed a bear market in oil from mid-2022 until the war began at the end of February 2026. We attributed it to weakening demand out of China. In the past, DXY and Brent crude oil prices tended to be inversely correlated. The FIBER Industrial Materials Spot Price Index seems to be peaking. In the past, the DXY has also been inversely correlated with commodity prices. (chart). Meanwhile, copper's strength since last year is best explained by demand for AI infrastructure and is not indicative of a Sell America Trade (chart). (4) Stocks. The downtrends in the Stay Home versus Go Global ratios since early last year appear to confirm the Sell America story (chart). We think it has more to do with global portfolio rebalancing, as the US now accounts for over 60% of the All Country World MSCI's market capitalization. (5) Bonds. The US 10-year Treasury bond yield has remained range-bound, contrary to the bearish implications of the Sell America narrative (chart). Warsh's commitment to price stability, combined with the plunge in oil prices, is restoring confidence that inflation will moderate in the coming months, as shown by a decline in breakeven inflation rates (chart). (6) Capital flows. The Dollar Debasement Trade predicted that foreigners would be selling US securities. The US Treasury International Capital (TIC) data show the opposite. Private net capital inflows into the US remained robust at $1.3 trillion on a 12-month basis through April (chart). Official accounts showed net capital inflows at only $88.0 billion over the same period. They certainly haven't been net sellers.
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