In 30 seconds: Analysts argue that persistent services inflation, deglobalization, and the end of China-driven goods deflation represent a structural inflation regime, with strong retail sales and GDP growth reinforcing the case that inflation is not merely an oil-driven supply shock. Brad Setser details how China's state banks appear to be warehousing over $1 trillion in foreign exchange off the PBOC's official balance sheet, obscuring the true scale of China's currency intervention and capital flows. A strike on Saudi Arabia's East-West pipeline knocked out significant Red Sea export capacity, with partial restoration expected within days but full recovery weeks away, driving diesel futures sharply higher amid the ongoing US-Iran war.
The comfortable story about inflation is that it was a supply shock, it is fading, and the Fed can declare victory. The uncomfortable story is that the supply shock merely revealed a regime change that was already underway. The data increasingly favor the uncomfortable story. On the goods side, core goods inflation flipped from deflationary — averaging -0.50% for 18 years after China joined the WTO — to averaging 1.82% over the last 6 years post-COVID. The WTO-era of goods deflation — when core goods inflation ran at -0.50% for 18 years — is over. The real economy is not cooperating with the disinflation narrative either. August retail sales rose 1.2% month over month, blowing past the 0.8% estimate; the control group printed 1.4%. Service sector inflation tends to be sticky, and the New York Fed's Business Leaders Survey shows prices paid and prices received with continued upward momentum across service industries. 30-year mortgage rate: 6.97%. Sustained inflation headwinds over the years have pushed even middle to upper-middle income consumers to behave more like lower-income ones. The US hit that 130% debt/GDP threshold in summer 2020. Services inflation has ALWAYS been a problem. Even during the China WTO-era, services inflation averaged 2.50% — above the Fed's 2% target. Post-COVID, services inflation is now averaging nearly 4% and remains above the 3% range.
If you want to understand how much foreign exchange China actually controls, the official reserve figures are, at best, a partial answer. The more interesting number sits on the balance sheets of China's state banks, and it is large enough to matter. China's state banks separately hold $1.2 trillion in foreign exchange assets. The mechanics are not subtle. This is intervention by other means. The point is that China's true intervention footprint is far larger than the reserve headline suggests. When you warehouse over a trillion dollars off the central bank's official books, you have not avoided intervention. You have just made it harder to measure. Which, if you are running the operation, may be the whole idea.
Reports suggest roughly 50% of capacity could return within days, but even at half throughput the kingdom would still see more than a 50% decline from pre-attack Saudi Red Sea exports given that west coast domestic refiners alone consume 1-1.5 million barrels per day. The US diesel futures curve is, technically speaking, wild. Spot diesel has reached $6.27 per gallon. The supply picture is not helped by the fact that global refining capacities wouldn't return immediately, as damaged facilities take time to repair. Venezuelan crude imports into the US hit nearly 800,000 barrels a day last week, the highest since mid-2017.
Here is what your portfolio did this session.
S&P 500: 7,551.81, down 0.45% on the day
10-Year Treasury yield: 5.01%, up 1 bp on the day
30-Year Treasury yield: 5.35%, down 1 bp on the day
13-Week T-Bill yield: 3.97%, up 1 bp on the day
Gold: $4,306.30, down 0.61% on the day
Fed funds rate: 3.75, flat 0.00% on the day
Long bonds (TLT): $80.88, up 0.21% on the day