The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt
In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere
It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions. For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm. Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year. Which means that the entire argument is based on dueling forecasts of the future beyond that. In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.
What is transitory? Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now. According to Merriam-Webster, it describes something of brief duration or temporary. Which begs the question, what is brief? Is 3 months brief? 6 months? Longer? Arguably, brief depends on the context involved. For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.
There continue to be strong arguments in favor of both sides of the argument. On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years. No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices. As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items. Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral. In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.
Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains. In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices. We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation. Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support. As they are wont to say, the Fed can’t print copper or corn. The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?
Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets. By now, you are all aware I remain in the inflationist camp and have been for a while. I cannot ignore the rising prices I see every time I go into a store. But the deflationists make excellent points. This argument discussion will rage for at least another two months and the July CPI release. Until then, the one thing that seems clear is that market volatility is likely to remain significant.
As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed. At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well. US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.
Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively. Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.
Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).
Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs. Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%). Much of this movement seems to be on the back of positioning rather than fundamental news. On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.
EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region. CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line. On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.
Not a ton of data this week, but here is what we see:
|Friday||Existing Home Sales||6.08M|
The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total. Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.
With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck. This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along. If you are in the deflationist camp, it’s the opposite. But remember, at a point in time, inflation will undermine the dollar’s value. Just not right away.
Good luck and stay safe