Inflation has become “an obsession” for many market participants, Morgan Stanley’s Mike Wilson wrote, in a Tuesday note.
The Fed’s “transitory” banter is already a standing joke among traders and certainly among finance-focused social media. That, despite the impossibility of ascertaining whether the Committee’s position on the issue is accurate.
We can’t know what we don’t know. That’s a tautology, but one gets the distinct impression that folks have already made up their minds — inflation won’t be transitory, so we all have a green light to lampoon policymakers in the here and now.
In addition to the impossibility of assessing how durable the inflationary impulse will ultimately be ahead of time, it’s also likely that the market’s favorite gauge of expectations is severely distorted, as discussed here over the weekend.
Read more: The Reality Of Distorted ‘Expectations’
After reminding investors that Morgan’s house view has long been that inflation would surprise to the upside, marking “the end of secular stagnation and ultimately financial repression much like that experienced post WWII,” Wilson on Tuesday said that not only has consensus come to agree, but in fact may be a bit too zealous.
“Inflation is now much more the consensus view,” so much so that “we are starting to think expectations may need a bit of a reset before inflation can really embed itself into expectations and force the Fed to move away from its ‘transitory’ view,” Wilson wrote, noting that color from PMIs is “laden” with commentary that suggests “prices are getting out of control for many businesses.”
Last month, I called some of the PMI color “downright silly,” to the extent the descriptions around demand and price pressures crossed the threshold into outlandish superlatives and alarmist balderdash.
Morgan Stanley also highlighted the surge in inflation expectations among consumers, as manifested most clearly in the University of Michigan’s gauges.
Recall that in addition to the year-ahead price outlook surging the second-most in three decades, a record proportion of consumers reported higher prices for discretionary purchases like homes, vehicles, and household durables in May (figure below).
“From our standpoint this is the beginning of a new trend that is more sustainable and less transitory than perhaps the Fed thinks,” Morgan’s Wilson remarked, before conceding that the bank “would not be surprised if there is some demand destruction in the short term and overheating that leads to consumer sentiment cooling a bit.”
That harkens back to points I’ve made previously in these pages. You can charge $17 for a package of Fudge Rounds if you want, but that doesn’t mean anyone will buy them. (Incidentally, a quick Google search reveals that I can pick up an 8 pack, curbside, from Walmart for just $1.96, cheaper than the gas it would cost me to get there.)
Finally, Wilson alluded to some of the same dynamics discussed here over the weekend in the first linked article above. “Inflation expectations have gotten ahead of reality in the bond market too,” he said, noting “extreme positioning in TIPs.”
What does it all mean? Well, it means that forthcoming CPI prints will be closely watched, but that’s stating the obvious.
Across assets, Wilson cautioned that “any disappointment in the next data series could unleash some pain for very crowded consensus trades – long commodities, TIPs, reflation winners and short dollar and interest rate sensitive assets.”
Of course, downside CPI prints wouldn’t necessarily be a “disappointment” for consumers, even as I’m compelled to remind readers that no matter what some gold-themed blog or Twitter personality might be peddling today, you don’t want to live in an economy defined by persistent, intractable deflation. That’s not a recipe for economic dynamism.
Oh, and as for equities, Morgan’s Wilson noted that if breakevens do come down in a scenario where the data comes in cool, it “would simply be an accelerant” for de-rating, given that “higher real rates and less ability to pass on higher prices would be a bad cocktail for multiples writ large.”
