Sticky inflation for second month in a row

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Good morning. Yesterday's red-hot consumer price inflation data didn't stop the S&P 500 from hitting another record high, nor did it stop the AI ​​hype from continuing. Nvidia, a company that's making a serious bet on artificial intelligence, and Super Micro Computer, a company that's semi-serious, both gained about 7%. According to Bank of America, total capital expenditures by Microsoft, Amazon, Alphabet and Meta will reach $180 billion by 2024, an increase of 27%. At this rate, we're going to have to revise our view of “this isn't a bubble” to “well, until you all go crazy, this isn't a bubble.” Email us at: robert.armstrong@ft.com and ethan.wu@ft.com.

Consumer Price Index, Part 2

After the release of last month’s consumer price index report, which was hotter than expected, Unhedged wrote an article titled “Calm down on CPI, everyone.” The conclusion is:

It would be a different story if February was just as hot. For now, reserve judgment.

Well, one month has passed, and the CPI rose again in February, but the increase was smaller. How worried should we be? Last time, we thought there were four backdrops that made January's inflation report look less dire. For the sake of consistency, we thought we'd revisit them:

• “The Fed views inflation expectations as the single most important factor in achieving inflation, but inflation expectations are falling.”

  Still roughly correct, but not as convincing as it was a month ago. Three- and five-year consumer inflation expectations have risen over the past month, as have break-even points, the market's best guess at future inflation. The most dramatic moves occur at the two-year breakeven point (even though the underlying market is thin and noisy), while the long-term breakeven point still looks calm:

• “January inflation reports tend to be volatile.”

  This seems about right. Analysts suspect a “January effect” caused by annual employment and supplier contract updates that is difficult to eliminate through seasonal adjustments has pushed up some labor-intensive price categories. Many of these services resumed in February, including medical services, personal care and restaurants. The staggering increase in landlord-equivalent rents — so much so that the Bureau of Labor Statistics held a public webinar to explain why it happened — also resumed.

• “The recent news has been much better for personal consumption expenditure inflation, which is the Fed's target.”

  Not so much anymore. Last month, we used Goldman Sachs' core PCE forecasts to visualize PCE so far. The good news:

  

  But higher-than-expected January data and expected limited relief in February painted a bleaker picture. In the updated chart below, we use Goldman Sachs' latest February core PCE forecast (0.27% monthly growth, 3.3% annualized growth). The six-month average is closer to 3%:

  

• “Housing inflation will still cool further, but no one knows when.”

  There is no clarity. Headline housing inflation slowed to 0.4% in February from 0.6% in January. But this is just a return to the previous speed. We are still waiting for the much anticipated convergence between CPI hedge data and new rents data. The chart below from Pantheon Macro tells an optimistic story. But you could equally argue that the CPI has been worryingly high and steady for almost a year now:

  

So far, the situation is not encouraging. However, some other February data also illuminated the inflation outlook. A 0.9% surge in super core inflation (core services excluding housing) in January proved to be short-lived. Some gains in February look fleeting, such as a 3.6% rise in airfares (possibly a one-off response to rising jet fuel costs) and a 0.5% rise in used car prices (after recent declines in wholesale auction prices).

Also remember that wage growth is slowing, which may help keep inflation in check. It is possible that inflation picked up in the first quarter and subsided in the second quarter. But the likelihood of inflation stabilizing closer to 3% rather than 2% is slowly growing. (Ethan Wu)

Why JPMorgan is so dominant, Part 2: Structure over skill

On Monday, I wrote an article about how JPMorgan Chase is absolutely outperforming the U.S. banking industry. There is something mysterious about its dominance. People expect to see big players in technology getting bigger and stronger, but that's less so in the banking industry. The banking industry does have some characteristics that create scale effects—for example, fixed management and regulatory costs that lead to operating leverage for larger players. But capital, the core product of banking, is a commodity. Unlike some commodities, it is difficult for companies to become undisputed producers of low-cost capital. Therefore, one would not expect to see a small number of banks occupying a majority of the market and one bank dominating those few banks. How did J.P. Morgan do it?

Readers wrote in that most people attributed JPMorgan Chase's dominance to superior management. Some pointed out that it avoided the huge mistakes made by rivals such as Wells Fargo and Citigroup (both of whom pointed out that the London Whale was unsightly). Others point out that banking is basically just risk management and that JPMorgan is just better at knowing which risks to take and how much to take. A well-known recent example is JPMorgan Chase's decision to hold low-yielding cash when interest rates were low rather than earn more returns by investing in long-term government securities. Rival Bank of America has taken the opposite approach. Interest rates have risen appropriately, Bank of America has huge unrealized losses on its long-term bonds, and JPMorgan is free to invest at higher rates.

Many other readers have said that Jamie Dimon is a very good CEO, both at the level of operational detail and strategic vision (a rare combination). In fact, it's hard to find anyone who denies this.

But let me declare my bias: While I do believe that good management can make a company better, large companies that consistently produce outperformance and dominate their industries almost always have built-in structural advantages. Therefore, it is best to look for these structural characteristics before considering management excellence.

Clearly, one of JPMorgan's strengths is its diversified business model. Especially under the post-2008 regulatory regime, where high leverage and short-term wholesale financing are not accepted, and asset risk weights are also very important, having a large retail banking business that matches investment banking and trading operations is an advantage. The retail business provides deposit funding and assets suitable for securitization, such as mortgages and credit card loans. In a world where investors prefer stable fee-based businesses, wealth management and payments processing support banks' valuations and lower their costs of capital. JPMorgan Chase has all these things and had scale before Dimon became CEO 20 years ago. He inherits an ideal platform for growth in a post-crisis world.

Once a bank has the right growth platform and starts growing, that growth tends to compound. Recent research finds significant and consistent returns to scale in the banking industry. For example, the Federal Reserve and Clemson University economics professors David Wheelock and Paul Wilson each argued in a 2017 paper that the conventional view of returns to scale in the banking industry is wrong. This wisdom holds that returns to scale are cost-driven and run out once a bank reaches a few hundred million dollars in assets. Looking at both the pre-crisis period of 2006 and the post-crisis period of 2015, they found a significant relationship between growth and incremental returns, even for the largest banks, and that for some of the very largest banks, returns came from both revenue and earnings, And not just the cost. Increased scale helps increase returns, and these higher returns can be reinvested in growth.

Still, general results like those of Wheelock and Wilson don't fully explain what JPMorgan has accomplished. The bank's growth rate over the past 20 years has been impressive. Across its investment bank, commercial bank and retail bank, assets have grown at a compound rate of about 6% per year (an exact number is difficult to come by because JPMorgan has changed its unit reporting structure over the years). If that doesn't sound like a high growth rate, remember it started with $750 billion in assets. The compound growth rate of customer assets in the wealth management field is 10%. Other departments are almost as impressive. Notably, return on equity in the bank's main businesses – investments and retail banking – increased despite a sharp decline in leverage – the amount of borrowed funds used to generate those returns.

JPMorgan's dominance was not just a result of its corporate structure being perfectly adapted to the times and the increasing returns to scale prevalent in the banking industry. It won't take long to find out what this might be.

A good read

Martin Wolf talks about China’s worldview.

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