Now, what if inflation is not
As transit’ry as Powell thought?
And what if there’s slowing
Instead of more growing?
Would that be a Gordian knot?
Well, lately the bond market’s view
Appears to be, in ‘Twenty-two
Inflation will soar
Much higher before
The Fed figures out what to do
The Fed has been pushing the transitory inflation narrative for quite a while now, but lately, they have been struggling to get people to accept it at face value. You can tell this is the case because pretty much every third story in any newsfeed is about rising prices in some product or service. Commodities are particularly well represented in these stories, especially energy, as oil, NatGas and coal have all seen dramatic price rises in the past month or so. It is also important to understand that despite the durm und strang regarding the continued use of coal as an energy source, it remains the largest source of electricity worldwide. I bring this up because the situation in China is one where the country is restricting energy use due to a lack of coal available to burn. (Perhaps one of the reasons for this is the Chinese, in a snit over Australia calling them out as to the origins of Covid-19, banned Australian coal imports.)
From an inflation perspective, this has the following consequences: less coal leads to less electricity production which leads to restrictions on electricity use by industry which leads to reduced production of everything. Given China’s importance in the global supply chain for most products, less production leads to shortages and, presto, higher prices. And this is not going to end anytime soon. Much to the Fed’s chagrin, they can print neither coal nor NatGas and help mend those broken supply chains. Thus, despite their (and every other central bank’s) efforts to repeal the laws of supply and demand, those laws still exist. So, just as April showers lead to May flowers, less supply leads to higher prices.
The difference in the past week or so is that bond markets worldwide have started to cotton on to the idea that inflation is not transitory after all. Yields have been rising and curves steepening, but even the front end of yield curves, where central banks have the most impact, have seen yields rise. So, a quick look at global bond markets today shows yields higher in every major market around the world. Treasuries (+1.1bps) have not moved that far overnight but are higher by 12bps in the past week. Gilts (+4.8bps) on the other hand, have seen real selling in today’s session, also rising 12bps in the past week, but on a lower base (10-year Gilts yield 1.125% vs. 1.58% for Treasuries.) And the same situation prevails in Bunds (+2.6bps, +6.6bps in past week), OATs (+2.5bps) and the rest of Europe. Asia is not immune to this with even JGB’s (+1.2bps, +4bps in past week) selling off. The point is that bond investors are starting to recognize that inflation may be more persistent after all. And if the Fed loses control over their narrative, they have much bigger problems. Forward guidance remains a key monetary policy tool, arguably more important that the Fed Funds rate these days, so if that is no longer effective, what will they do?
Needless to say, risk attitudes are starting to change somewhat as concern grows that almost the entire central banking community, certainly the Fed and ECB, will be too slow to react to very clear inflation signals. In this situation, financial assets will definitely suffer. Keep that in mind as you look ahead.
OK, next we need to look to this morning’s NFP report as that has been a key element of the recent market inactivity. Investors are looking for confirmation that the Fed is going to begin tapering next month and have certainly been encouraged by both the ADP Employment number as well as yesterday’s much lower than expected Initial Claims data. Here’s what current median forecasts look like:
|Average Hourly Earnings||0.4% (4.6% Y/Y)|
|Average Weekly Hours||34.7|
Powell explained that as long as this report was not terrible, he felt the tapering would begin. Interestingly, the range of forecasts is 0K to 750K, a pretty wide range of disagreement as to how things might play out. Certainly, a number like last month’s 235K could throw a wrench into the tapering process. Personally, my take is slightly weaker than median, but not enough to change the taper idea.
On a different note, I cannot help but look at the Average Hourly Earnings forecasts and wonder how any Fed speaker can argue that wages aren’t growing rapidly. Absent the Covid induced gyrations, 4.6% is the highest number in the series by far going back to early 2007. Again, this speaks to persistent inflationary pressures, not transient ones.
But we will know shortly how things turn out, so a quick recap before then shows that equity markets had a good session in Asia (Nikkei +1.3%, Hang Seng +0.55%, Shanghai +0.7%) but are less giddy in Europe (DAX -0.1%, CAC -0.4%, FTSE 100 0.0%). Meanwhile, US futures are essentially unchanged ahead of the data.
We’ve already discussed the bond market selloff and cannot be surprised that commodity prices are mostly higher led by oil (+0.8%) and NatGas (+0.1%), but also seeing strength in gold (+0.3%). Industrial metals are having a rougher go of it (Cu -0.3%, Al -0.4%) and Ags are a bit firmer this morning with all three major grains higher by about 0.55%.
As to the dollar, it is mixed this morning ahead of the data with the largest gainer NOK (+0.4%) on the back of oil’s strength, while SEK (+0.3%) is also firmer although with no clear driver other than positioning ahead of the data. On the downside, JPY (-0.15%) continues under pressure as higher US yields continue to attract Japanese investors.
EMG currencies have seen a more negative session with PLN (-0.6%), TRY (-0.5%) and RUB (-0.5%) all under pressure and the APAC bloc mostly falling, albeit not quite as far. The zloty story seems to be concerns over a judicial ruling that puts Poland further at odds with the EU which has been sufficient to offset the boost from yesterday’s surprise rate hike. In Turkey, a story that President Erdogan is “cooling” on his view toward the central bank governor seems to have markets nervous while in Russia, rising inflation and limited central bank response has investors concerned despite oil’s rally.
There are no Fed speakers on the calendar today so it will all be about the NFP number. Until then, don’t look for much, and afterwards, there is typically a short burst of activity and a slow afternoon. I don’t think the big trend of dollar strength has ended by any means, but it is not clear today will see much of a gain.
Good luck, good weekend and stay safe