If inflation is such a problem ...
Why are bond yields range-bound?
… what’s up with the 10-year Treasury yield? Even though Google searches for “inflation” are at peak popularity and “inflation” mentions skyrocketed 800% year-over-year (y/y) in earnings calls, bond yields have trended down since late March, and 10-year and 5-year breakeven rates have moved off their highs. Fundstrat believes the bond market leads the equity market and observes the former hardly flinched over the past week despite multiple equity market palpitations on inflation (y/y core PCE jumped in April, more below) and the crypto crash. One reason may be investors have largely priced in the V, with positive economic surprises nosediving over the past month. Neutral readings are consistent with rangebound yields. There are mounting signs of “peak growth,’’ with consumer spending moderating last month (more below) and the May nonfarm payrolls consensus at 620K (and falling), putting the 2-month total for April and May at less than half the 2 million that had been expected. Applied Global Macro Research thinks the U.S. is setting up for core PCE inflation to run around 2.25% y/y through 2022 (within the Fed’s elevated target). Some prices already have started to subside—oil, iron ore and lumber among them, and inflation expectations have rolled over modestly. It’s no surprise inflation’s going to run hot for months, and not just because of base effects as negative numbers from a year ago when the economy shut down roll off. Massive monetary and fiscal stimulus, strong U.S. and accelerating global growth, rising wages and rents, pent-up demand and excess savings are bound to trickle down to prices. But some combination of slower growth in demand and faster growth in supply eventually should correct these imbalances, as the history of capitalism tells us they almost always do.
It’s been lonely worrying about MMT and the dollar. U.S. debt-to-GDP is on a course to challenge 1946’s 118.8% record, with the “bipartisan’’ infrastructure talks more about posturing than negotiating. The White House’s $1.7 trillion counteroffer—down $500 billion from its initial plan—was still nearly three times the Republican’s initial counter, with the spending that was cut already included in other legislation moving through Congress. The GOP’s newer counter of nearly $1 trillion narrows the gap but would use unspent funds from already approved stimulus to pay for it. That’s a nonstarter. Meanwhile, President Biden today unveils a 2022 fiscal budget that seeks to increase federal spending to $6 trillion, with annual deficits of $1.3 trillion over the next decade. Seems budget reconciliation and its simple majority approval remains the administration’s primary play. MMT it is. Then there’s the Fed. Although several FOMC members have indicated they’d like a taper discussion to start sooner rather than later, Chair Powell wants to see a “string” of strong nonfarm payroll reports before he’s comfortable even thinking about thinking about tapering. As for the first rate hike, BCA Research calls expectations of a move by early 2023 “cuckoo land.’’ Powell emphasizes the new Fed regime views “maximum employment” as a broad-based and inclusive goal, and specifically cites the benefits a strong economy brings to low- and moderate- income communities. Policy is to be based on the extent to which employment falls short of, rather than deviates from, its maximum level—a seemingly subtle shift that in actuality represents a dramatic change in the view of my fixed-income colleague R.J. Gallo. I’d wager you’ll be hearing more and more about MMT, no longer a theory. A Fed that hews to zero-bound while numerous central banks around the world start to tighten, and a fiscal policy racking up record debts year after year can’t be good for the dollar. It’s starting to weaken and could worsen, creating what Wolfe Research considers the most underestimated and unappreciated potential downside catalyst. Thank you!!
What we have right now is a tug of war between inflation concerns and sleepy summer trading. Could get volatile, especially with seasonality turning more challenging. While last year’s quickest recovery from a 30% drawdown in history, fastest economic rebound in decades and easy monetary policy globally support the secular bull case, the market’s mid-May 4% pullback off a strong run was the mildest in more than six decades and could presage a bigger correction if the choppiness continues. Strategas Research thinks the recent S&P 500 low of 4,057 will be an important line in the sand, particularly given modest momentum leakage under the surface. The index is roughly at the same level it was at on April 15, but 92% of issues were above the 50-day then versus 69% now. Then again, May’s mild sell-off came against a backdrop of violent corrections in purported bubbles in Bitcoin, Tesla and SPACs. Stocks were supposed to roll over when that happened but have not. It’s looking more like a healthy sector rotation amid an earnings upgrade boom. Q1’s earnings season was the fourth straight record-setter, demonstrating consensus can’t get optimistic enough—a cyclical recovery combined with the emergence of a productivity boom (more below). Even if there are fewer upside surprises, growth is going strong as we continue to reopen (more below). So, inflation is either temporary or it’s not. Since we have never experienced a post-pandemic reopening with over-the-top stimulus and a “new regime” Fed, it is hard to tell how long it will take for the inflation drama to play out. We might as well go on summer vacation. But wait, there are no rental cars to be had, and airline and vacation rentals have doubled or tripled in price. Actually, Pittsburgh’s very nice this time of year. Happy hour on my deck!
- Americans just want to have fun TrendMacro’s real-time measure of restaurant utilization in 40 states shows 27 are seating more customers than before the pandemic. Despite topping $3 a gallon for the first time in seven years, gasoline demand is back to 2019 seasonal levels. TSA checkpoint volumes at airports are almost at pre-Covid levels, with telephone hold times for Delta running nearly 8 hours (not a typo). JFK is packed, with 19 times more people than three months ago. And just try renting a car—a 4-day rental in San Francisco is $963 versus $375 two weeks ago.
- Productivity sounds boring, but it’s not Productivity-enhancing non-defense capital goods orders burst out to new highs in April, a positive sign for addressing shortages (inventories to sales are at a post-war low) and inflation. Rising productivity matters for stock performance, too, offering support for profit margins under pressure in this expansion from rising wages, interest rates, regulations and potentially taxes.
- Home equity soaring Homeowners have been big beneficiaries even as spiking home prices have deterred buyers (more below). Price gauges shot up nearly 14% y/y in March with solid increases across regions, including the Midwest, which hasn't such growth for decades. House prices were up 10-20% y/y in Cincinnati, Cleveland, Columbus and Youngstown, Ohio, as well as in Detroit, Grand Rapids, Lansing and Flint, Mich.
- Steel yourself—could be just temporary! The latest report to show inflation rising came out this morning, with headline and core PCE both in somewhat higher than expected. Headline PCE climbed 3.6% y/y, a 13-year high, while core PCE came in at 3.1% y/y. Higher inflation and bond yields have replaced Covid variants as the market’s No. 1 concern, according to Deutsche Bank.
- Housing’s sharp V-shaped rebound is over Both pending and new home sales fell again in April, as record-low supplies and record-high prices kept prospective buyers at bay. Purchase applications also have started trending down, even with the average 30-year mortgage rate falling back to near 3%, and builder confidence has plateaued. To be sure, the market remains hot, just less accessible at these price and supply levels.
- When the checks quit coming After jumping 21% in March, April personal income fell 13% as the stimulus checks quit showing up. Consumer spending moderated to, rising just 0.5% versus March’s nearly 5% surge. Both Conference Board and Michigan consumer sentiment gauges pulled back, the latter in part on rising inflation worries.
Negative reinforcement Weekly initial jobless claims fell again to just above 400K, and continuing claims dropped, too—signs fewer people are staying home and collecting enriched benefit checks. With Florida coming on board this week, 24 states have now opted out of the supplement federal benefits, accounting for 40% of the U.S. labor force.
The impact of rising wages arguably is overstated Bank of America notes overall market margins have been immunized by efficiency/automation gains relative to prior decades, with the number of employees per $1 million in sales declining from around 8 in 1986 to 2.3 today. Overall, S&P companies are 70% less labor intensive now than they were then.
India remains a mystery In December, no one knew why the sub-continent wasn't having an infection wave like everywhere else. Then in March, no one knew why it suddenly had a horrific wave when nowhere else did. Now that wave is visibly subsiding; TrendMacro says no one knows why.