ARK Extends An Open Letter To The Fed

In ARK’s latest In The Know video, out of concern that the Fed is making a policy error that will cause deflation, we offered some data for our “data-driven” Fed to consider as it prepares for its next decision on November 2. In the face of conflicting data, the unanimity of the Fed’s last decision to increase the Fed funds rate by 75 basis points was surprising.

In this summary, we delineate first the upstream price deflation that is likely to turn into downstream deflation. Then, we focus on the two variables––employment and headline inflation––upon which the Fed seems to be making its decisions. In our view, both are lagging indicators.

Commodity prices are leading indicators, upstream in the stages of processing. Most commodity prices have peaked and, except for food and energy, are falling on a year-over-year basis, as shown below. Without question, food and energy prices are important, but we do not believe that the Fed should be fighting and exacerbating the global pain associated with a supply shock to agriculture and energy commodities caused by Russia’s invasion of Ukraine.

Source: ARK Investment Management LLC, 2022. Data from Bloomberg as of last close, 10/7/2022.

*According to Fastmarkets’ RISI Pricing Data, containerboard prices dropped 29% in September and are down ~53% year-over-year. Containerboard correlates to commerce-related shipments.

Downstream, inventory accumulation seems to be overwhelming manufacturers and retailers. After grappling with supply chain constraints for more than a year, even world class companies seem to have overruled their automated enterprise resource planning (ERP) systems and over-ordered merchandise. In the face of single-digit sales growth, inventories at Walmart and Target increased 25.5% and 36.1%, respectively, during the most recent quarter. Nike’s recent quarterly results suggest that the inventory imbalances have worsened. Despite sales growth of only 3.6%, Nike’s inventories increased 44.2% globally. In North America and on ships in transit, its inventories increased 64.8% and 85.0%, respectively! In the auto sector, used car price inflation as measured by the Manheim used value index peaked at 54.2% on a year-over-year basis in April 2021 and made another run to 46.6% in December 2021, but have dropped 13.5% year to date and now are down 0.1% year-over-year.[1] Facing inventory losses, used car dealers are likely to disgorge more inventories, which could push price inflation deeply into negative territory.

The Fed seems focused on two variables that, in our view, are lagging indicators––downstream inflation and employment––both of which have been sending conflicting signals and should be calling into question the Fed’s unanimous call for higher interest rates. During September and early October, the Fed felt vindicated in its tough stance by reports that inflation as measured by both the CPI and PCE Deflator[2] excluding food and energy increased 0.6% (7~-8% annualized) and that the PPI[3] excluding food and energy increased 0.4% (~5% annualized). Including food and energy, the CPI increased and the PPI fell 0.1% (~1% annualized), however, while home prices as measured by the Federal Housing Finance Agency (FHFA) fell 0.6% (~7-8% annualized). Reported on the employment front during September and early October, initial claims for unemployment insurance declined and nonfarm payroll employment increased 263,000, but job openings as measured by JOLTS[4] fell 10% or 1.1 million, manufacturing employment as measured by the ISM Purchasing Managers Index[5] contracted, and Challenger involuntary job separations soared 67.6% on a year-over-year basis.[6]

Unanimous? Really?

Could it be that the unprecedented 13-fold increase in interest rates during the last six months––likely 16-fold come November 2––has shocked not just the US but the world and raised the risks of a deflationary bust?