10Y economy inflation

Still No ‘Motive For Murder’?

After Tuesday, you might be in need of a palliative vis-à-vis your growing sense of angst about what effect the ongoing bond rout will have on your previously bulletproof collection of grossly overvalued equities.

After Tuesday, you might be in need of a palliative vis-à-vis your growing sense of angst about what effect the ongoing bond rout will have on your previously bulletproof collection of grossly overvalued equities.

As you’re aware, there was nowhere to hide on Tuesday. It was a bloodbath. Or at least what counts as a bloodbath in a world where the MSCI World and the S&P have both set records for the longest stretch without a 5% correction.

The proximate cause for Tuesday’s (relative) carnage was of course the rapid rise in yields. It’s all about the “how far?” and “how fast?” and “what’s behind it?” How long will the market continue to view higher yields as indicative of the robustness of the recovery? At what point does the bond selloff become acute enough to spark a tantrum? And most importantly, at what point does the ultimate irony inherent in this whole charade finally manifest itself in the triumphant return of volatility across assets? Recall what we said first thing this morning:

We’ve spent the better part of a decade trying to engineer inflation, but the problem is that the policies we’ve employed in the service of that goal will be rolled back if “victory” is ever achieved.  Because those policies have served to underpin the rally in risk assets, it stands to reason that in the final analysis, no one really wants to declare victory over deflation if that means calling an end to the stimulus that’s underwriting the rally.

Ok, well on that score, Goldman has a soothing new note for you. There’s a lot of fun (or “not-so-fun”, depending on your penchant for wading through econometrics) discussion about trends in prices and how to deploy a model from a peer-reviewed academic article to isolate for permanent versus transitory inflation, but in the interest of not effectively forcing you to click away from this post by burdening you with the details, I’ll just hit you with the gist of it, which is this, via Goldman (note: “permanent” and “trend” are used interchangeably):

The results of applying the Stock-Watson model to headline CPI inflation are displayed in the [left] chart.  Two series are shown: the original inflation series (QoQ annualized), and the trend extracted by the model. It is clear at a glance that there were large swings in the trend component during the 1970s and 1980s which have settled down to almost nothing.


To compare the volatilities of trend and transitory CPI inflation, the [right] panel plots the model’s time-varying estimates of their respective volatilities (standard deviations). As this plot makes clear, the 1970s and 1980s were characterized by high levels of permanent inflation shocks, whereas the period since 2000, by contrast, has been characterized by highly subdued volatility of the trend amid the elevated volatility of (transitory) shocks from energy prices. Consistent with this contrast, historical accounts suggest that inflation shocks had dramatic effects on the bond market during the 1970s and 1980s, whereas they have had relatively less consequence since 2000.

Apparently realizing that not everyone will immediately understand why this is any semblance of useful, Goldman introduces their conclusions with this rather amusingly straightforward bit: “We conclude with a few observations on why investors should care.” We’ll just give you one of them. To wit:

Justification for the continued dovish conduct of monetary policy. The results here support our view that low and stable inflation bodes well for the longevity of the current expansion. As the well-known MIT economist Rudi Dornbusch liked to say, none of the post-war US expansions died of natural causes, they were “murdered” by the Fed while attempting to fight inflation. Low inflation rates and well-anchored inflation expectations provide central banks with little reason to tighten preemptively ─ no ‘motive for murder’ ─ which takes a leading source of recession risk off the table (at least for now).

Oh, and there is a bit of “bad” news. Goldman closes by noting that “while current low equity volatility appears to match the new lows made in the transitory volatility of some macro indicators, we do not think there has been a fundamental shift strong enough to offset cyclical factors when the expansion eventually slows.”

Sorry to end on a sour note…





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