Is the inflation scare over?
That might seem like an odd question to ask given that, prior to the crypto fireworks, inflation headlines dominated the front page.
And yet, 10-year breakevens just dropped by the most in eight months (figure below). Five-year breakevens are also lower, after hitting 16-year wides.
Last week’s decline came even as the color accompanying PMIs (both in the US and Europe) was nothing short of alarmist on the inflation front. IHS Markit continued to warn on acute price pressures, while price gauges from the Empire and Philly Fed surveys notched the highest levels in decades.
But the headline Philly Fed print missed estimates and some of the housing data came in below expectations too, albeit against a hopelessly distorted supply/demand backdrop. As Bloomberg’s Katherine Greifeld noted, Citi’s economic surprise gauge “briefly dropped into negative territory for the first time since June 2020.”
Commodities fell a second week, raising questions about the viability of calls for a new “supercycle.”
“Both real and nominal yields rose while inflation breakevens came under pressure as commodities reversed their recent gains,” SocGen’s rates team remarked, noting that the US data will likely “remain volatile as the economy gradually recovers.”
Last weekend, I talked quite a bit about the interplay between market-based measures of inflation expectations, media messaging and real-world views as manifested in, for example, consumer sentiment surveys.
Suggesting that one week of lower breakevens is somehow indicative of… well, of anything, is foolhardy. There’s no consensus. It’s all a waiting game. And the extent to which the apparent standoff between employers and workers is resolved in higher wages is key.
Notably in that regard, there’s a sense in which a decline in average compensation will be viewed going forward as a positive sign for the economy, if it means the hardest-hit sectors are beginning to normalize.
“As lower wage jobs come back into the system, lower AHE and AWE could actually be interpreted as a positive signal on the reintegration of more of the 22 million jobs initially lost to the pandemic in March and April of last year,” BMO’s Ian Lyngen and Ben Jeffery said, in a Friday note.
Ideally, we can get to some happy middle ground, where compensation for the lowest-paid workers rises (i.e., they’re paid enough to live a dignified existence), but not so much that it exacerbates the kind of inflationary dynamics that could ultimately prove detrimental to the very same people.
Next week’s data could prove incremental. New home sales are on deck, as is consumer confidence, personal income and spending and the final read on University of Michigan sentiment (recall that the preliminary release was accompanied by a rather dramatic uptick in inflation expectations.)
Note that the taper discussion (as tipped in the April Fed minutes) could point to higher real rates which, in turn, would be dollar positive and could weigh further on commodities, with obvious implications for inflation expectations (the market-derived variety, at least). Although “normalization” is a highly relative term these days, Fed officials are subtly guiding the market. “We’re on the backside of this crisis,” Barkin said Friday. “I think it makes sense to discuss the unintended side effects,” Kaplan reiterated, at the same event.
Whatever the case, this won’t be an ordinary summer. “The summer of ‘21 promises much more than the typical low conviction and volumes trading environment for US rates,” BMO’s Lyngen and Jeffery said. “The prospects for an accelerated return to normal holds the greatest potential for redefining the macro outlook.”
“Markets traded the ‘boom'” over the past six months, BofA’s Michael Hartnett wrote last week, citing the surge in commodities and cyclical value shares. For the past three months, markets traded the inflation story, as “froth” and hyper-growth slumped. In the second half of the year, Hartnett said the “pain trade” is stagflation.
Unit labor costs will be the key to understanding inflation. Just because lower wage workers get a raise does not necessarily mean that inflation takes off. A lot depends on the new world of work, both white collar, blue collar and service employment. The jury is out there. I can imagine Biden coming to some kind of agreement with Chinese and EU to reduce tarrifs on a lot of goods in exchange for better measurable cooperation. Likewise the spike in commodities is likely to prove fleeting. As logistical problems begin to unwind and producers figure out how to get more to market for incremental spending, my guess is that supply will start catching up to demand. Economic forecasters are basing much of their estimates on past economic cycles. This one really is completely different. Once the economy normalizes later this year, perhaps the forecasts will be more relevant.
Ria.
Thank you for your post it kind of puts things in perspective for me. Not to say Walt’s analysis is not helpful.