Call it yet another boost to the reflation narrative. Alternatively, you might call it a rather stark warning about the possibly imminent onset of actual, realized inflation.
The flash read on IHS Markit’s US services and composite PMIs for February topped estimates, and the manufacturing gauge was essentially inline. But that wasn’t the highlight.
Rather, the key takeaway was the color on prices. Which are rising. This is a case where quoting directly from the report is preferable to editorializing. The following passage is quite poignant, no embellishment required:
Input costs across manufacturing and services soared higher as demand outstripped supply, rising at by far the steepest rate since comparable data were first available in 2009. Service providers registered the steepest increase in cost burdens since October 2009, while manufacturers recorded the quickest rise since April 2011. As a result, firms raised their selling prices at the sharpest rate on record (since October 2009), with panelists stating the increase was due to the partial pass-through of greater costs to clients.
Yes, there’s an anecdotal element to that. But unless everyone is lying, price pressures are building all the way down the line, from input costs to the price of goods and services for end consumers.
“A concern is that firms’ costs have surged higher, driving selling prices for goods and services up at a survey record pace and hinting at a further increase in inflation,” Chris Williamson, Chief Business Economist at IHS Markit, remarked.
Obviously, pandemic-related supply chain issues are still working themselves out (or not working themselves out, apparently), and “extreme weather” got a mention too.
But the body of evidence pointing to a swift uptick in inflation is growing. This comes on the heels of blockbuster retail sales data for January and similar color from other surveys. You’ll recall that ISM prices paid surged last month, for example. A notable disconnect between the Philly Fed prices paid and prices received gauges (Thursday) was described by some as a potential warning sign for profitability, and Empire prices paid hit the highest since 2011 (Tuesday).
On the headline print, the flash read on IHS Markit’s services gauge for February was the highest since March of 2015.
The input prices gauge for the services sector hit 70.3, up from 66.9 in January.
Demand was strong “with firms often reporting higher activity as virus-related restrictions were partially eased and inflows of new business picked up,” the color accompanying the February report said.
On the manufacturing side, the input prices index hit 73.3, while the output prices gauge rose to the highest since July of 2008.
As alluded to above, the good news is that this in part reflects robust demand. The bad news (in addition to the inflationary read-through) is that it isn’t translating into robust hiring in the services sector.
“Employment growth remained relatively muted, as service providers were reluctant to expand workforce numbers amid efforts to cut costs and uncertainty about the near-term outlook due to the pandemic,” IHS Markit went on to say, noting that “manufacturing job creation accelerated, however, reaching the highest for just over three years.”
There again we see a kind of two-track recovery developing in the US, and not one that’s particularly conducive to success given the services-oriented nature of the economy.
Williamson summed it up pretty succinctly. “Business sentiment remains buoyant, boosted by hopes of further stimulus and the vaccine roll out, but it’s disappointing to see this not yet translate into stronger jobs growth.” The services sector, he cautioned, is “reluctant to hire” and remains “cautious about adding to overheads.”
What do you get when you combine rising prices with a labor market that is still 10 million jobs short of pre-recessionary levels? Nothing good, that’s for sure.
Although you can paper over the problem (figuratively and literally) in the near-term, that “papering” could potentially contribute to the malaise if it drives prices higher still.
Artificial demand is good to the extent it’s a bridge to real demand.
But… well, you get the idea.
My 2 cents is to say that the jawboning of inflation hysteria is way too early and based on very little data. Sure the apparent recovery and reflation thesis is out there, but that whole pile of crap data needs to be placed into the context of a one-in-a-century pandemic event. The data related to a V-recovery, is what it is, but, as far as I understand, there is still a global pandemic in place — and a new virus variant has been very busy studying human immunology, and its transmissibility capabilities are going to be put to a test in the next several weeks. With that uncertainty ahead and so much damage within the last year, I don’t think it’s the right time to over-interpret or hyperventilate about inflationary anxiety. There are better things to worry about, like what happens to the 10-yr Treasury rate once the 2-yr Treasury heads below zero.
What dynamics and models do we have to explain that possibility? Inflation is a fairly easy bogey monster that most likely isn’t going to explode from under the bed and cause some hyperinflation nightmare — instead, pondering the nightmares related to an overheated equities market reacting to a totally distorted Treasury Dept, warped currency moves and the Fed trapped in a Black Hole, is a far more entertaining liquidity drama. For example, how will a sub-zero 2 yr Treasury impact mortgage rates or swaps or CDS or Bitcoin?
The pandemic drama isn’t over and IMHO, the Inflation Overture, currently playing will reach a sudden short crescendo fairly soon, then like Gamestop, something more substantial will swell in our hearts and minds.
Various Plumbing issues
IMF, Aug 2020
“The downside to yield curve control is that, given the size and global nature of the Treasury market, enforcing a yield target could require very large purchases of government bonds, which, in turn, could increase risks to the
Fed’s balance sheet (that would rise along with the duration of the bonds that are purchased).
Furthermore, there is relatively little empirical evidence on the extent to which yield curve control
can boost demand and support a faster recovery (especially when yields are already at historic lows).
Finally, capping yields will inevitably dampen the important price signals that the Treasury markets
provide (at least at shorter maturities).”
Re1: FRA-OIS, already at the tightest level in at least a decade, is about to go negative. Zoltan has more:
To have a view on FRA-OIS, we need to have a view on who will warehouse $1 trillion of reserves that will flood the system by June. Large U.S. banks won’t be able to unless they get SLR relief at the bank operating subsidiary level.
Re2: “The implications for FRA-OIS from here are obvious: if U.S. banks are full and money funds can’t take new money either, foreign banks will warehouse reserves at rates below those of J.P. Morgan but above those available in the bill market – and both are negative. The price of warehousing is a fee, i.e. a negative rate…”
Re3: “- Zoltan expects U.S. dollar Libor-OIS spreads to reach zero by June, with risks to the downside. “
Benchmark interest rates when the government is risky?
FRBFS
Patrick Augustin, et al, September 21, 2019
A small probability of U.S. Treasury default lowers no-arbitrage bounds of swap spreads to negative levels. Specifically, accounting for a U.S. credit risk premium in Treasuries is crucial if one wants to explain the dynamics of the term structures of multiple benchmark interest rates jointly. Even if the probability of a U.S. credit event is small, the risk premium associated with it may be large.