There once was a world where the price
Of stuff stayed the same…paradise
But then central banks
Were born, and now thanks
To them prices rise in a trice
Now, worldwide the story’s the same
As these banks, inflation, can’t tame
They’re all terrified
That stocks might just slide
And they would come in for the blame
“I’d expect price increases to level off, and we’ll go back to inflation that’s closer to the 2% that we consider normal. In the 70’s and 80’s inflation expectations became embedded in the American psyche. That isn’t happening now.” So said Treasury Secretary Yellen yesterday in an interview on NPR. One has to wonder on what she bases these expectations. Certainly not on any of the evidence as per the most recent data releases.
For instance, the NY Fed’s latest Inflation expectation survey was released yesterday with 1-year (5.7%) and 3-year (4.2%) both at the highest level in the series’ history since it began in 2013. She cannot be looking at yesterday’s PPI data (8.6%, 6.8% core) as an indicator given both of these are at their highest level on a final demand basis since PPI started being measured in this manner in 2011. However, a look a little deeper at the intermediate levels, earlier in the supply chain, show inflation running at levels between 11.8% and 27.8% Y/Y. While all of these costs are not likely to flow into the price of finished goods, you can be sure that the pressure to raise prices throughout the chain for both goods and services remains great. And of course, later this morning we will see the CPI data (exp 5.9% Y/Y, 4.3% ex food & energy) with both indicators forecast to show substantial increases from last month. Secretary Yellen continues to try to sell the transitory story and twelve months of increasing prices later, it is wearing thin.
The US, though, is not the only place with this problem, it is a global issue. Last night China released its inflation readings with PPI (13.5%) rising far more than expected and touching levels not seen since 1995. CPI there rose to 1.5%, a tick higher than expected which indicates that either there is a serious lack of final demand in the country or they are simply manipulating the data to demonstrate that the government is in control. (In fact, it is always remarkable to me when a Chinese data point is released that is not exactly as expected given the control the government exerts on every aspect of the process.) Regardless, the fact is that price pressures continue to rise in China on the back of rising energy costs and shortages of available energy, and ultimately, given China’s status as the world’s largest exporter, those costs are going to feed into other nations’ import prices.
How about Europe? Well, German CPI rose 4.5% Y/Y in October, the highest level since September 1993 in the wake of the German reunification which dramatically shook up the economy there. Remember, too, the German’s have a severe phobia over inflation given the history of the Weimar Hyperinflation, so discontent with the ECB’s performance is growing apace in the country.
Essentially, it is abundantly clear that rising prices have become the norm, and that any idea that we are going to ease back to moderate inflation in the near-term are fantasy. Naturally, with inflationary pressures abundant, one might expect that central banks would be out to address them by tightening policy. And yet, while peripheral nations have already done so, the biggest countries remain extremely reluctant to tighten as concern over economic output and employment growth continue to dominate their thoughts.
Historically, central bank decision making always required balancing the two competing goals of
pumping up supporting the economy while preventing prices from running away. Between the GFC and the pandemic, though, there was no need to worry as measured inflation never reared its ugly head, so easy money supported growth with no inflationary consequences. But post-pandemic fiscal largess has changed the equation and now central banks have to make a decision, with significant political blowback to either choice. Yet the biggest risk is the lack of a decisiveness may well lead to the worst of all worlds, rising prices and slowing growth, i.e. stagflation. I promise you a stagflationary environment will be devastating to financial assets all over.
Now, as we await the CPI data, let’s take a look around the markets to see how traders and investors are responding to all the latest news and data.
Equity markets are mostly following the US lead from yesterday with declines throughout most of Asia (Nikkei -0.6%, Hang Seng +0.7%, Shanghai -0.4%) and most of Europe (DAX -0.2%, CAC -0.3%, FTSE 100 +0.4%). US futures are all pointing lower at this hour as well (DOW -0.3%, SPX -0.3%, NASDAQ -0.5%) so there is little in the way of joy at the current moment. Risk is definitely under pressure.
What’s interesting is that bonds are not seen as a viable replacement despite declining stock prices as yields in Treasuries (+2.7bps) and throughout Europe (Bunds +0.8bps, OATs +2.1bps, Gilts +3.4bps) are higher. So, stocks are lower and bonds are lower. Did I mention that stagflation would be negative for financial assets?
On this very negative day, commodity prices, too, are under pressure with oil (-0.6%), NatGas (-1.8%), gold (-0.35%), copper (-0.3%) and tin (-1.1%) all suffering. In fact, throughout the entire commodity complex, only aluminum (+2.0%) and corn (+0.5%) are showing gains. At this point, oil remains in a strong uptrend, so any pullback is likely technical in nature. NatGas continues to respond to the glorious weather in the northeast and Midwest with reduced near-term demand. Even in Europe, Gazprom has finally started to let some more gas flow hence reducing price pressures there although it remains multiples of the US price.
Turning to the dollar, it is today’s clear winner, gaining against 9 of its G10 brethren, with CAD (flat) the only currency holding its own. SEK (-0.6%) and NOK (-0.5%) lead the way lower with the latter tracking oil’s declines while the former is simply showing off its high beta characteristics with respect to dollar movement. In the EMG bloc, TRY (-1.1%) is the laggard as traders anticipate another interest rate cut, despite high inflation, and there is concern over the fiscal situation given significant foreign debt payments are due next week. ZAR (-0.9%) is slumping on the commodity story as well as concerns that the budget policy may sacrifice the currency on the altar of domestic needs. But the weakness extends throughout the space with APAC currencies under pressure as well as LATAM currencies. This is a dollar story today, with very little holding up to the perceived stability of the buck.
As well as the CPI data, given tomorrow’s holiday, we see Initial (exp 260K) and Continuing (2050K) Claims at 8:30. There are actually no further Fed speakers today with Bullard yesterday remarking that two rate hikes were likely in 2022. We shall see.
With the inflation narrative so strong, this morning’s data will be key to determining the short-term direction of markets. A higher than expected print is likely to see further declines in both stocks and bonds with the dollar benefitting. A weaker outcome seems likely to unleash yet another bout of risk acquisition with the opposite effects.
Good luck and stay safe