“'Cause you're hot then you're cold You're yes then you're no You're in then you're out You're up then you're down”
I've been on track to become a Swiftie since the day she conducted herself admirably against Kanye West at the VMA Awards in 2009. It's amusing to see grown men in positions of power picking fights with her.
Mixed signals
Recent US inflation data has sent mixed signals regarding whether the disinflation cycle has concluded or has further to run. Within the context of price fluctuations observed over the past two years, the variations are within rounding errors. Not long ago, used car prices were increasing by 10% on a monthly basis.
This is a roundabout way of stating that there is much ado about nothing. The market could be trading at the same levels today under a different set of economic data (within reason), and the rest is simply down to an unwinding of crowded positions.
Analysts moving more than the data
Although the recent divergences in inflation data are small compared to historical levels, the shifts in the US outlook among some market economists with each new set of data releases have been grossly exaggerated. A notable independent US economist has been topped and tailed in a spectacular manner: initially predicting significantly higher rates until early Q4 2023 (more vocal near the highs on bond yields), then reversing course after a 130 basis point (bp) rally in 10-year US Treasury yields a couple of weeks ago, forecasting that the Fed would cut rates sooner and by more than market expectations. Now, the economist aligns with the consensus view that there will be a regular cut (25 bp) at the June 2024 FOMC meeting.
This situation occurs, hopefully not too frequently. The justifications for each reversal of opinion are amusing for reasons other than the obvious… my analysis was flawed.
Summers on Fed rate hike risk
Larry Summers recently estimated a 15% chance that the Fed's next move would be a rate hike rather than a cut. Given the current evidence, this seems accurate. The question is: what probability does he assign to the central bank keeping policy rates unchanged throughout 2024? We estimate roughly a 50 basis point (bp) rate cut, influenced by the disinflation phenomenon in 2023.
Here's our rough estimate of the probability distribution of Fed Funds rates by the end of 2024:
Hedging for improbable scenarios
Ordinarily, option hedges are costly. However, investors optimistic about USD rates, assigning less than a 10% probability to a rate hike scenario, may find options hedges valuable while implied volatilities are low. Options hedging strategies are most beneficial when premiums are relatively inexpensive and aimed at guarding against unlikely scenarios. It's less about exploiting volatility and gamma opportunities and more about timely mental rebalancing.
Mortgage-rent convergence
The recent increase in shelter costs in the inflation data is unsurprising. We can refer to the chart below, which illustrates the significant gap between mortgage costs and rents:
Uncertainties in official calculation methodologies
Mapping alternative price data to official constituent inflation measures continues to be a challenge, partly due to differences in calculation methodology. We have extensively discussed shelter costs and owner's equivalent rent in the consumer price index (CPI). Beyond housing, health care insurance represents another significant expense for those not receiving it as part of their employment benefits, such as the self-employed and small business owners.
Who is pocketing the extra money?
Medical professionals report that these price increases are not passed on to them by insurance companies. For example, the total bill for an ACL ligament repair surgery through Stanford Medical Care amounts to $50-70K, of which approximately $1K goes to the surgeon when billed through insurance. With comprehensive insurance coverage, the patient pays around $500 out of pocket as a deductible. The US spends twice the OECD average as a proportion of GDP on health care, without achieving better outcomes for patients.
Widening gap between PCE health care inflation and premiums
While the average monthly health insurance premium paid by Americans has increased by approximately 20% since 2019, prices have risen by only 6% according to the personal consumption expenditure (PCE) inflation over the same period.
The middle-aged spread
Here is how health insurance rates increase with age:
The combination of aging and general premium increases has led to an overall +30-40% increase in monthly payments for the average 40-50-year-old since 2019. This is another source of voter discontent, in addition to the lack of affordable housing.
