Albert Edwards is back with is tri-weekly weekly.
You’re reminded that Albert is like Gandalf (the wizard, not JPM’s Marko Kolanovic): “Albert Edwards is never late. Nor is Albert ever early. Albert arrives precisely when he means to.”
Well, Edwards “meant to” arrive today, and so that’s “precisely” when he arrived and he’s revisiting something he mentioned in his last note. Namely this point from his October 26 missive:
Wage inflation has been the dog that didnt bark this year – or indeed the wolf that didnt howl.
The nightmare scenario for equities would be if US wage inflation flickers back to life and investors not only decide that they are too far behind the Fed dots, but they also decide that the Fed itself is behind the tightening curve.
So that’s the context for today’s note which find’s SocGen’s incorrigible (but affable) bear delivering some characteristically colorful musings on wage inflation, complete with a history lesson on “Red Robbo.”
The overarching theme here is the tedious and increasingly contentious Phillips Curve debate. Edwards begins by channeling another affable SocGen employee, Kit Juckes…
Quoth Kit, quoth Albert:
What matters from here, of course, is the outlook for inflation. Clients tell me that strategists fall into one of two camps – those who believe faster wage growth and the revival of the Phillips Curve is just around the corner, and those who have completely given up: they see no reason to look for higher inflation and they therefore have no reason to expect the range in bond yields to break. The ranks of the latter camp have grown dangerously large and this is now the consensus view. Maybe that’s why the dollar is making such heavy weather of bouncing.
And so the implication there is the same as it was before: namely that if wage inflation shows up and causes everyone to question whether everyone else is behind the curve (and “behind the curve” has at least three applications in that context, so it’s a triple entendre), the market is in trouble. On that point Edwards goes on to quote another SocGen employee: himself…
Quoth Albert, quoth Edwards:
Indeed throughout this cycle wage inflation has been the dog that failed to bark. The risk is that the market is hugely vulnerable if it hears a distant bark, let alone feels its bite.
Next Edwards sorts through the standard explanations for why wage inflation isn’t showing up before citing some evidence for the contention that we might not be measuring what we think we’re measuring. The upshot of it all is best captured in this excerpt:
The supposed flattening of the Phillips Curve (which effectively means that low rates of unemployment result in more moderate wage inflation) is probably the most important economic event boosting asset prices at the moment, because it is prompting a much more relaxed pace of central bank interest rate increases than would usually be the case.
Additionally, he flags the disconnect between a benign inflation backdrop and positive economic surprises. To wit:
My former colleague, Paul Jackson, now at Source ETFs, points out that normally positive economic surprises of this size would generate a sizable bond sell-off (see chart below) but not now.
On the rare occasions the close correlation above has broken, it is because the US data might be upbeat, but it is weaker elsewhere eg see end 2014 above when strong US data did not prompt a rise in yields (see below). Currently all regions economic data are surprisingly strong. Hence the lack of a more pronounced bond-sell is most curious and also worrying.
Of course that backdrop – i.e. benign inflation but generally upbeat econ data – is part and parcel of the whole “Goldilocks” rationale for risk assets. Markets can point to steady growth as a reason to stay long and to subdued inflation as a reason to believe central banks won’t get too aggressive and thereby short-circuit the risk rally.
Implicit there is the idea that if inflation does show up and central banks are forced to act without the market’s “consent” – well then look out.
Now who’s ready for the punchline? [Raise your hands]
Here’s Albert to deliver it as only he can…
More Americans plan to take a holiday in the next six months than ever before (see chart below). No wonder it was so difficult to book hotels in Yosemite National Park and Lake Tahoe next May! I know US consumer confidence has been booming on the back of a surging equity market, but cheap money has also prompted the consumer to book holidays galore. When the bubble bursts, households will be mighty pissed that its not just their wealth that evaporates in front of their eyes but their ability to vacation like never before.