5 Things To Know In Investing This Week - The Inflation And Oil Issue

This was a big week for connected events. The increase in the CPI was a surprise to the disinflation crowd that’s been screaming for lower interest rates for almost two years. Higher CPI leads to higher for longer interest rates which pushes up the dollar against the yen. That’s about to force the Bank of Japan to act by selling US Treasuries increasing the already stratospheric borrowing cost of the US government. On the commodity side of things, the White House decided to pass on replenishing the Strategic Petroleum Reserve as oil prices now approach $90 a barrel after passing on replenishing the SPR when oil was below $70. Guest, Tracy Shuchart @chigrl explains that worldwide oil inventories are falling even as the Saudis and Russians maintain extended production cuts. Check her out on this week’s video version of the 5 Things out Monday night. Finally, we highlight some of the ways commercial real estate landlords are legally lying. If it seems complicated, don’t worry: We’ll explain…

This week, we’ll address the following topics:

• The CPI comes in high. The disinflation story is crumbling. Am I going to say “the line”? See below to find out.

• The Bank of Japan is being forced to act. That’s going to have negative consequences for the US. We’ll explain why.

• The Commodity Trader in Chief missed the big trade and plans to execute the “fingers crossed” strategy going into the fall hurricane season.

• It’s not just domestic oil supply. Tracy Shuchart @chigrl explains that global oil inventories are declining as well. Another guest thing – check out Tracy on this week’s video edition.

• Commercial real estate gets worse. Office landlords are finding creative ways to tell the “truth”.

I want to offer a round of applause for last week’s guest, DKI Board Member, Howard Freedland, who gave a well-reasoned explanation of the effect of the new broker commission rules on pricing for housing and commercial real estate. Another round of applause for DKI Intern, Andrew Brown, who prepares the graphs for the 5 Things, pitches several of the Things we use each week, edits and posts the video, and was an on-air guest explaining the errors in recent Congressional Budget Office projections. Pretty impressive for a college “kid”. Thanks also to Flying V CEO, Robb Fahrion, who shows up well-prepared each week to host the 5 Things.

Ready for a new week of more expensive information? Let’s dive in:

• The CPI Comes in High and is Still Understated:

The March Consumer Price Index (CPI) was up 3.5% for the year and 0.4% for the month. That annualizes to 4.9%. This was above last month’s 3.2% and expectations of 3.4%. The still-high Core CPI, which excludes food and energy, remained at 3.8%. That’s almost double the Fed’s 2% target. The energy price declines which fueled last year’s disinflation story have reversed as crude and gasoline prices rise. (Disinflation is inflation at a slower rate.) Shelter, a fancy word for housing, continues to rise in price causing some people to start to pay their rent using buy now pay later programs! And DKI continues to express skepticism at any report that claims food inflation was 2.2%. Readers:  Is your grocery bill up only 2.2%?

Core remains sticky. The CPI is heading back up again.

The real interest rate is the CPI less the fed funds rate. We’re back below 2%.

DKI Takeaway:  When the market thought we’d have six rate cuts (totaling 1.5%) this year starting in January, DKI said “we find that hard to believe”. When the market thought we’d see three rate cuts (.75%) this year starting in June, DKI said “we don’t think so”. The current debate is now between zero and two cuts starting in September. This is a blow to political incumbents facing re-election in November who were hoping for fed-fueled stimulus. All of this is the reason DKI subscribers have been making great profits in dollar alternatives and inflation beneficiaries like Bitcoin, gold, and oil/energy. You know the conclusion: “higher for longer”.

• The Bank of Japan is Being Forced to Act:

I started speaking and writing about serious problems related to Japan’s massive debt in October of 2022. The Bank of Japan (BoJ) had kept their version of the fed funds rate below zero for years, and only recently moved to slightly positive. Those below-market rates led to the yen plummeting from just over 100 to the dollar to the current 153 per dollar. In the US, we don’t like to see an inflation rate above 2%. Imagine the buying power of your currency falling by 50% in just a few years. With debt to GDP of over 260%, the BoJ is now stuck. The options are to keep rates where they are, and watch their currency crumble, or raise rates and have to print more yen to pay higher interest expense. There’s no way out.

The line going up shows the loss of purchasing power for the yen.

DKI Takeaway:  Trillions of dollars have been invested in the “carry trade” which involves selling low-yielding Japanese Government Bonds and buying higher-yielding US Treasuries. This strategy provided guaranteed profits on the difference in bond yields, but came with the risk that the relative value of the dollar and yen could reverse. With the yen falling to 153 per dollar this week, the BoJ is likely to react by selling holdings of US Treasuries, effectively selling the dollar and buying the yen. When investors start to unwind the carry trade, we’ll see enough selling of US Treasuries to lower the price of US government debt increasing the yield. That would increase the already massive interest expense being incurred on our behalf by Washington DC and force more dollar printing. The result of that would be more inflation. We’re happy to see more people starting to recognize this problem with more articles in the press and attention on Twitter/X. If you’d value knowing these kinds of things a year and a half before they’re common knowledge, we invite you to subscribe.

1. The Commodity Trader in Chief Missed the Big Trade:

Faced with high inflation and skyrocketing energy prices in 2022, the White House made a huge gamble. They drained the Strategic Petroleum Reserve (SPR) to a 40-year low in order to bring down gas prices ahead of the midterm elections. Without a big hurricane that fall to take oil production offline, the strategy worked. Gas prices fell and the Democrats outperformed expectations in that election. The Administration stated an intention to replenish the SPR when oil fell into the $70s. However, they passed on any meaningful activity when West Texas Intermediate (WTI) crude oil prices fell into the high $60s in mid-2023 and again in the low $70s last December. With WTI now trading at $87, the White House cancelled an intended purchase of 3MM barrels.

The last time the SPR was this low, the population of the US was 35% lower.

DKI Takeaway:  The SPR was intended to be insurance against geopolitical volatility, not a political piggy bank. Currently, we have a war in the Middle East and another involving Russia, two huge oil-producing regions. Additional issues related to Red Sea shipping and restrictions on exports of Russian oil are making energy transportation more challenging. With inflation and the economy as the top issues for US voters, the White House is going to do all they can to try to keep the price of gas low heading into the November election. This strategy leaves the US more exposed to both international problems and a potential fall hurricane. We’re hoping this doesn’t lead to a national security issue.

• Global Oil Inventories Are Declining:

Tracy Shuchart @chigrl notes: The US Energy Information Administration, after forecasting global inventories to remain unchanged this quarter, now predicts they’ll fall by 900,000 barrels a day. That’s the equivalent to the production from Oman. The supply squeeze comes as demand is ramping up. US refiners are preparing to boost fuel production for the summer, when millions of Americans take to the roads and gasoline consumption peaks. Gasoline stockpiles on the populous East Coast are tightening and manufacturing activity in the US and China is also signaling a boost in fuel use. In Asia, refining margins are around 50% higher than the five-year seasonal average, suggesting healthy demand. (from Bloomberg)

Lower inventories lead to higher prices.

DKI Takeaway:  This means higher for longer unless OPEC+ decides to discontinue its voluntary cuts of over 1M bpd at the June 1, 2024 meeting. Saudi Arabia is shouldering the burden of most of these cuts, so ultimately, it’s their decision. Both the EIA Short term Energy Outlook and the OPEC monthly that were released this week anticipate the US to add ~360K bpd in 2024. We disagree with this due to reductions in rigs, DUC (drilled but uncompleted), new wells, and higher GOR (gas to oil ratio). However, with OPEC expecting US production to grow, this gives Saudi Arabia incentive to maintain current production levels in order to keep prices elevated to fund their aggressive agenda to turn Saudi Arabia into a world-renowned tourist destination, and other large projects.

• The Problems in Commercial Real Estate Are Getting Worse:

We’ve been reporting on problems in the commercial real estate sector for the past few editions of The Five Things. More people moving away from big cities combined with employees’ insistence on working from home/anywhere are putting pressure on the commercial office space market. One way landlords are hiding the problem is with giveaways. The scheme works like this:  With vacancies high, tenants have leverage to insist on lower rent. In order to avoid reporting rent decreases which would reduce the implied value of the building, the landlord will insist on maintaining the same listed rent while offering the tenant free months or rebates for expensive renovations. The effective rent is lower, but the discount is hidden.

Chart from the Wall Street Journal.

DKI Takeaway:  DKI has spent the past three years writing about how government statistics like the CPI, GDP, and the recent employment reports have been faked, revised when few were looking, or just lies. Unfortunately, misleading and fake data isn’t limited to the government. When real estate companies report rents that are high only due to undisclosed giveaways, it’s technically legal, technically not a lie, and deliberately designed to mislead investors. The commercial real estate market is worse than the official statistics indicate, and we applaud the Wall Street Journal for covering this almost-fraud in detail.

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