CPI & PPI inflation numbers came in hotter than expected
Oil Prices continue to pressure overall prices higher, and this will continue for the foreseeable future
So what?
Bond yields may have halted their rapid increases seen over the past few months, and I expect inflation to be contained from here
But…
The real issue may be the AI Trade which looks like it is finally being called into question
Inflation is higher in the United States, and the big story right now is the price of oil. The disruption of the flow of oil through the Strait of Hormuz continues to be the cause since the United States and Israel attacked Iran.
Additionally, what Americans pay at the pump for gas prices is not the only cause driving price pressures: price pressures were first driven by the tariffs as the Federal Reserve branch of New York pointed out a report on how tariffs added to the initial increases in inflation.
The latest CPI & PPI reports surprised the bond markets, which then sold off bonds sharply last week; this sent yields significantly higher. The stock market sold off in tandem, but as it turns out, the stock market selling brought in buyers of bonds in the flight-to-quality trade.
Although many believe that the Federal Reserve is going to be actively working to contain inflation, I do not believe that interest rates are going much higher right now. I think there is a lot of concern in the markets, and the flight-to-quality may be the next big move in the markets. Having long-end yields as high as they are will actually help the Fed fight inflation. Then, hopefully there will be positive news coming out of the Middle East, and price pressures will abate.
Producer Price Index
Headline final-demand rose +6.3% for PPI and an additional +5.0% on core goods; less food and energy prices.
PPI final-demand energy rose 10.8% for September, month-over-month. This was 80% of the increase in final-demand goods prices—just gasoline alone.
The war has been going on for over 7 months. While I do not expect a resolution soon, something positive should develop eventually.
Unfortunately, oil flows will take a very long time to resume to normal. Prices may still drop up front on a massive, positive development. My rationale on that is simply that prices have not gone anywhere near as high as the worst-case scenarios should have predetermined.
Consumer Price Index
Both headline and core CPI increased higher. Again, gasoline was a big culprit in this with the Bureau of Labor Statistics pointing out that more than half of the headline increase on CPI was from the 9.1% increase in gas prices at the pump in September; month-over-month from August.
While the consumer is seeing up-front increases in some areas, most of the increases in inflation were fuel related, and you can see the PPI pressure trickling through, this is not a guarantee of firms passing all costs downward. Some firms work on an indirect cost related structure, and some of those firms may swallow some of the shipping costs. That means that even CPI may be somewhat contained in the future.
You can see the big spike up in the yield on the 10 from last week, and then the immediate selloff—that’s flight-to-quality.
I think the yield may be capped at these levels for now. There is a tremendous amount of concern in the markets right now, and cash may begin to flow into the Treasury market, diminishing other rationale for selling bonds–we’ll see. If the AI trade actually falters, which there have been solid moves occurring just last week, profit-taking might ensue at these higher levels.
The potential of selling in AI stocks is developing, and something that every market pundit has been predicting for some time, including me.
I don’t think the AI trade is a bubble, but a pyramid scheme where every company that has future obligations or cashflow projections are stacked on the performance of many other companies.
OpenAI has obligations of some $300B to Oracle alone over the next 5 years beginning in January 2027. While this is arithmetically $60B annually, it does not necessarily mean OpenAI begins paying that amount of revenue to Oracle. OpenAI has a current revenue run-rate of some $50B-$70B, which may meet that obligation. Unfortunately, OpenAI has other obligations, and not 100% of that revenue would go to Oracle—OpenAI needs to continue building its customer base.
OpenAI may get wiggle room from Oracle in that they are not at 100% in their build-outs, which means that although OpenAI is on the hook to pay for used capacity, the capacity is not necessarily available. This becomes a serious timing mismatch between building infrastructure, financial commitments, customer growth, and revenues.
Thus begins the concerns of the amount of debt being taken on by companies, which if build-outs do not meet scheduling, and even more debt is taken on by some companies, how does this get paid for on a timely basis?
Hence, CoreWeave CRWV stock selling off on concerns.
In the simplest of terms, the math does not math.
And, then, all of these companies need to revamp and upgrade their respective facilities, which would entail even more debt.
All of the circular financing is based upon many companies performing simultaneously, but a lot of companies are falling somewhat short. The markets are taking notice.
To me, this is a pyramid scheme of sorts, and the circularity has the potential to implode on itself if one company dramatically fails to perform–we are seeing some companies fall short of their stated performance, which that may call into question the companies they are required to perform for: Circular pyramid scheme.
I got out of my TLT ETF trade some two weeks ago, as mentioned in my previous post. I do not believe we see continued selling in the bond markets, and a lot of this is driven by the fact that eventually we will see resolution in Iranian war, and by extension lowering of fuel prices. This will take time, but the markets are the world’s greatest discounters of future information.
I also think there may be the potential of large moves downward in the stock market if continued selling ensues because of the circular pyramid scheme.
I still hold a sizable option position looking for SPY ETF to move downward prior to year’s end. I believe that the pieces of the puzzle are beginning to look a lot more clear, and this is likely to play out accordingly.
