Disinflation disappears

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. GameStop, which is less a retailer than a pile of cash controlled by an ambitious iconoclast, wants to buy eBay, which is a real and much larger company. Ebay has rejected the idea, which probably isn’t the end of the story. But even if it is, the whole thing is an interesting case study in the limits of financial engineering. We made a podcast about it. Listen in and tell us what you think: [email protected]

Today, me on US inflation, and Daire on gilt market discipline.

US CPI

Headline CPI inflation rose in April, dragged higher by energy prices. No news there. But core inflation is a somewhat more surprising and complicated story. Our preferred measure, month-over-month change annualised, shows core inflation (which excludes food and energy) at a nasty 4.6 per cent in April: 

But the core is not all that bad when you look under the hood. Since last year’s government shutdown, the CPI’s measure of housing inflation has been somewhat distorted, because statisticians chose to record a zero reading in place of the missing data period. This pushed up core inflation last month (in a few months, this methodological quirk won’t matter). But even with housing taken out, services inflation still looks elevated:

The market did not panic. The two-year Treasury yield rose 5 basis points to around 4 per cent. No one had expected the Federal Reserve to cut interest rates at its next meeting anyway — that is, some of the bad news about services inflation was already priced in. But this report put another big nail in the coffin of the disinflation story.

An important side note: as of now, AI looks like an inflationary force, not a productivity-enhancing inflation buffer. See the 11 per cent increase in the prices of computers and other hardware in April. Jan Hatzius at Goldman Sachs points out that while computer and software prices don’t have much weight in core CPI, it is much more heavily weighted in core PCE, the Fed’s preferred measure, which we’ll see out in two weeks. And Matthew Luzzetti from Deutsche Bank explains that AI-related demand is leading to higher prices elsewhere: 

AI has triggered a substantial positive aggregate demand shock, as investment has surged in anything AI-related, including software, chips, computers and peripheral equipment, and data centres. These investments are competing with alternative demands for resources . . . In addition, AI is likely to represent an ongoing source of demand that could create bottlenecks and price pressures in key points of the supply chain — the spillover to higher electricity prices is most obvious. 

Inflation isn’t out of control. But it is above target, and it is hard to see why it would fall any time soon.

The return of the moron risk premium

It’s been a wild week for gilts, and it’s only Wednesday morning. Yesterday the yield on the 10-year shot up above 5 per cent for the second time in a few days. It’s become obligatory to note that government borrowing costs are at their highest since 2008, or 1998 if you’re looking at the very long end of the rate curve:

The reasons are obvious: inflation is above target, the energy shock is weighing on growth and the government of Prime Minister Sir Keir Starmer might or might not be about to collapse. Last week’s local elections went very badly for the Labour Party. Markets have been assuming that whoever succeeds him will crank up borrowing, testing the bond market’s ability to absorb supply.

Is there money to be made betting the other way? In 2022, gilts sold off in response to the “mini-budget” of then prime minister Liz Truss, after markets concluded that she and her chancellor, Kwasi Kwarteng, were not fiscally serious people. The Bank of England stepped in to backstop the market by purchasing £19.3bn of gilts at a steep discount — and then unwound the portfolio for a £3.5bn profit.

In a weird way, the bond market has become Starmer’s most powerful ally. Each time gilts sell off a little in response to a ministerial resignation, the market gives the Labour Party an unpleasant taste of life without him. In effect, the bond market is playing a role the parliamentary party will not: enforcer of fiscal discipline.

But even if you believe the market will rein in Starmer’s potential successor, there’s a risk that yields will have to go higher before they go lower. In 2022, Dario Perkins of TS Lombard coined the “moron risk premium” to describe the additional compensation demanded by investors to hold gilts when the UK government is led by the fiscally, if not intellectually, challenged. Back then, though, we knew who the moron was. In 2026, they have yet to identify themselves. And the market doesn’t like surprises.

One good read

Wartime marketing austerity.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.