TLDR: The methodology of calculating US CPI data will change next month and due to this change we will likely see a steep drop in inflation in the coming months, which will give the Fed the cover for a reversal in monetary policy come the start of Q2.We have seen a continued drop of inflation across the US and Europe, which has caused plenty of investors to call for inflation being ‘defeated’ and the highs not to be seen again. While I believe we have lower to go for inflation first, perhaps even heading towards the Fed’s 2-3% target or slightly above there, everything is shaping up for a major renewed inflationary wave come the second half of this year. This is not what most are preparing for right now, but it is something that needs to be kept in the back of one’s mind. I wouldn’t be surprised to see US inflation numbers coming in at 10-12% or higher within the next 12-18 months, which would light a major fire under the commodities and energy space.The problem with inflation slowing in the meantime, is that elevated inflation and as an extension the major bubble across almost all asset classes ensured that the US could keep operating within their means to fund the true interest expenses. This is not the case anymore and one just has to take a single glance at the state of US tax receipts, which is a metric that I have been highlighting since Q3 of last year as a data point that would have a major impact going forward, because now the tax receipts are falling significantly (to the tune of 11% and 7% year over years respectively for November and December). This year we will likely see this trend continue and that puts the US in the precarious situation of being at risk of a significant monetary crisis, unless the Fed steps in.What the Fed needs is something breaking or a form of cover to ensure that they can reverse their monetary policy without losing too much credibility. Inflation coming down would give them that cover. Something that may help speed this up, but which does not seem to be talked about a lot, is that the way CPI inflation is calculated will change next month (https://www.financialexpress.com/investing-abroad/featured-stories/us-cpi-calculation-to-change-for-january-inflation-data/2944976/).Instead of taking into account two years of consumption data, it will only be based on one year and that changes the game for the Fed entirely. Come April, we will likely see this have a significant effect and produce a number that will be closer to what the Fed has been aiming for. All else equal, this change in methodology will have an immediate effect this quarter and in Q2.If this comes to pass and we remain on the current trajectory, inflation will drop another 2-3% in part because of this change in methodology. If this is combined with the Fed raising its inflation target, or having to reverse monetary policy because something fundamentally breaks in the financial system (overseas or ‘at home’), we have just gotten a clear timeframe for a pivot by the Fed (around the start of Q2). There remains a systemic risk of a final correction before we get to that point, as the wheels are slowly starting to come off and problems in the treasury market (as well as Dollar liquidity) could fuel another sell-off, but the long awaited pivot by the Fed has now been put on the table and I believe this change in methodology could be the final piece of the puzzle that will see a pause and subsequent rate cuts starting in Q2 and going into the end of the year and 2024.What will perform best if we see a reversal in monetary policy and a second wave of inflation? I would argue it will be commodities and energy, as these asset classes have entered a new cyclical bull market and have just come off the back of a decade of underinvestment. As the prices of raw materials go up (uranium, oil, gas, copper, silver etc.), the underlying equities will outperform.I hope this post will prove to be informative and please always do your own due diligence. Have a good and healthy rest of your day.
