They’re Buying It

They’re buying it. Figuratively and literally.

Global equities looked for a fourth consecutive weekly gain and 10-year US yields were poised for their biggest weekly drop in a year (figures below), as market participants now appear on board with the Fed’s insistence that elevated inflation will prove transitory.

Colloquially, it felt like folks were just happy to have May CPI out of the way — glad to be clear of the event risk. Throw in some short covering and just like that, benchmark US yields were at three-month lows, supporting risk assets in the process. MSCI’s emerging market currency index hit a record Friday.

“Inflation is the macroeconomic equivalent of phantom limb pain — a problem long since cut out can still hurt,” Credit Suisse’s James Sweeney said, adding that “the pain comes through a reflexive fear of policy reactions to inflation risk – a different thing from actual inflation.”

If that “reflexive fear” is allayed by persistent promises from policymakers who are steadfast in the contention they won’t panic or otherwise exhibit any pretensions to preemptive tightening in the face of a handful of monthly inflation prints rife with distortions, market participants can be pacified.

It’s not just Fed cooing that’s emboldening markets and prompting traders to rethink the inflation story. As SocGen’s Albert Edwards wrote Thursday, “the key factor” when it comes to determining whether the current situation morphs into something more nefarious is wage inflation.

“Inflation needs leverage and leverage needs higher wage expectations,” TS Lombard said, echoing those sentiments. “To be clear, inflation is process not price changes, per se, and critical to this process is high expectations for salary raises.”

(Who’s expecting a massive raise? And if you are, are you confident enough in that prediction to go out and borrow against it with your credit card at Best Buy today?)

If fears continue to recede and bond yields are kept at bay, one obvious read-through is that hand-wringing over the prospect of an acute de-rating for an equity market trading exceptionally rich may abate. That said, it’s worth noting that if breakevens move lower and real yields rise, that could still pose a headwind for risk assets.

That latter caveat aside, the prevailing (rosy) narrative Friday was simply that with US yields now ~30bps off the local highs and Jerome Powell likely to be especially cautious about upsetting any apple carts with taper talk at the June meeting, risk assets have a green light.

That could prove misguided in hindsight (it might even seem quaint within days or even hours), but we need to craft narratives and tell stories to make sense of markets. After all, markets are human creations. There’s no such thing as “stocks” and “bonds” outside of our belief in them, so if we don’t write the story, there won’t be one.

Speak your mind

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16 thoughts on “They’re Buying It

    1. This is disingenuous. You’re not paying “10% more for everything.” These kinds of comments belong on Twitter, not here. Note that I do generally require constructive comments in these pages. That doesn’t mean you have to pen a tome, but if all you’ve got to offer is a tweet, take it to Twitter, where nebulous snark belongs.

      1. Ok then…

        Obviously I’m not paying 10% more for everything, although 10% (or more) for some things is is currently accurate.

        Lombard can define inflation in wage terms if he wants, but then we’ll need a new word for what consumers are currently experiencing. Perhaps the fed can alter their mandate to combat whatever that new term is.

      2. Furthermore, if we take Lombards definition of inflation to heart, wouldn’t it be part of the feds current mandate to ensure the masses don’t get raises rather than making sure prices for things don’t go up?

        I can only hope that those who run our command economy don’t see it that way.

        1. Fatmoose, it sounds like you’re being willfully obtuse. It’s pretty clear from the quote Heisenberg used that Lombard and A. Edwards are not defining inflation as wage increases, but rather pointing out that wage increases are a necessary catalyst for lasting inflation, and absent that catalyst it’s more likely this is only transient inflation.

          1. Ie, if prices rise and people aren’t paid more than the fed need not act. But if prices rise AND people are paid more then we have a problem…

            Also it seems to me that the argument there essentially relies on the Phillips curve (which has proven to be nearly irrelevant on the “maximum employment” side of things). If it proves to be irrelevant on this side of the curve as well can we finally retire it?

          2. Also, part of the quote is “To be clear, inflation is process not price changes, per se, and critical to this process is high expectations for salary raises.”

            That to me sounds a lot like a redefining of inflation as wage instability rather than price instability.

  1. Over the years the notion that” good inflation is what we need“ happens to be concurrent with pandemic supply constraints. How in the world anybody thinks we come through a pandemic, rather quickly actually, without a new paradigm is fighting the old war and not open to a new future. Barry Ritholtz has a good perspective on labor “inflation “

  2. The long term narrative of off-shoring jobs and replacing jobs with screens/AI/online remains in place.
    Did you see that McDonalds is testing AI order takers in 10 Chicago locations?
    The advice we gave our kids in high school remains to be good advice.
    Do anything you want. Just don’t choose something that can be easily replaced by a college graduate in a foreign country who is willing to work remotely and for a fraction of what people in the US are currently paid for that job.

  3. Two things: TS Lombard isn’t a “he,” it’s a firm. And see how much better this conversation turned out when comments are thoughtful as opposed to mere snark? That’s why I prompt people to elaborate. It stimulates better discussion.

  4. I hear you. Was (obviously) unfamiliar with Lombard and looked it up too late. Wish we could edit comments.

    As far as the sarcasm/snark, this subject is obviously makes me feel a certain way so it’s easier, both emotionally and from a labor perspective, to not rile myself (and my word count) up while still trying to get my point across. I admit that my initial attempt at that was not successful.

  5. The basic truth is that labor plays two roles in the economy. People are the consumers who buy the final goods and services provided by our companies. Without income they cannot do that. The ability to buy G & S is what my dusty old textbook called “effective demand.” Higher wages, especially for those earning average or below average pay, increase effective demand. Unfortunately, the other truth is that all labor represents a cost to businesses. There are only two strategic options for a firm to make more money. They can employ ways to increase revenue faster than total cost or they can decrease total costs without the sacrifice of revenue. The easier of the two choices in the short run is to decrease costs and labor, especially for service firms, is likely to be the largest single cost. The simple laws of economics, the ones we can mostly all agree on, will force firms to seek ways of keeping costs down. All costs have two components, price and quantity. Using less labor to get the same output is what we call increased productivity. Ask any worker how they feel about doing more work for the same money and they won’t be too polite. Besides, if we don’t raise wages some, people won’t be able to buy as much stuff. Tricky, huh? The other way to do the problem involving the cost of labor is outright substitution — technology replaces labor or offshore cheap labor replaces more expensive domestic labor. Technology costs tend to be fixed costs, unrelated to output volume. Once you break even on those costs, the rest is virtually pure bottom line profit — the benefit of operating leverage. So here we are. Businesses feel they have to minimize the cost of labor, but in doing so they constrain the incomes of their customers, reducing the growth of effective demand. We see this at work on a macro basis as profits soar, cash builds up in banks, and long-term growth is like 2% The dueling roles of people is the central problem, inflation is only an effect. Offshoring and technology substitution will take place, the question is how to maintain consumption in the long run and raise effective demand. Just sayin’

    1. Good points. It brings to mind the paradox of thrift we’ve often experienced when “kitchen table common sense” is used to justify macro-level austerity as a response to an economic downturn.

  6. One issue regarding the inflation related dialog that tends to be ignored is the fact that there has been for an extended period where ‘stealth inflation ‘ has occurred . By this I am referring to the gradual whittling away of the quantity of consumer items. Of late, this has accelerated pretty dramatically in common items purchased by the average consumer on a day to day basis… almost as if business by design is attempting to recover last years bad sales data . If not accounted for or noticed it inevitably will burden the poorest of society because they will have to step up quantity of purchases on common items. I am pretty certain CPI numbers do not reflect that data although I’m fairly certain the awareness is there . The trend is irreversible unless suddenly someone get a pang of conscience and adds the 1/4 oz back on that bar of soap or the 1/4″ inch onto the coffee filter , roll of toilet paper or candy bar… All argues against the ‘transitory’ narrative as does the level of state and local taxes based on (temporary ??) increased valuations… Long term cost of living I think will tend to rise (more than expected ) and this will pressure wages more than expected … Lately there have been several mentions on this topic here so this issue could get a lot more mainstream press soon.

  7. We are in the midst of, or have recently passed through, peak inflation hype. The markets responded the most when inflation talk was starting to accelerate. By the time “OMG Inflation!!!” is on every mainstream media channel, and the talk starts decelerating, the market has moved on to the next thing.

    This presumes that the market is treating “OMG Inflation!!!” like just yet another phase in the news cycle – something for everyone to obsess over for a couple of months, that drives a rotation, then gets supplanted by the next “OMG _______!!!”. As opposed to something that is here and real and to stay to dominate economies for year(s).

    Which it indeed seems to be doing. There are plenty of reasons – I mean considered, analytical, data-based reasons – why you’d do that. Granted there are also some reasons you might not, but one way has you fighting market momentum and the Fed, and the other doesn’t. A fight that keeps getting lost is a fight best watched from the sidelines until the losing stops (ahem, Melvin Capital).

    So, while we wait and see about actual inflation – as a reminder, a violent but short jump in prices is not economic inflation, any more than a violent but short fall in prices is economic deflation – it is probably more profitable to focus on the next “OMG______!!!” thing.

    For sure, keep some inflation bets on. Whether that’s oil, energy stocks, financials, commodities, TIPS, etc, I would think you don’t whack those to zero, but if you pushed those sliders hard a couple-few months ago, you are probably easing thosecsliders back and finding other sliders to push up.

    What sliders are people eyeing? Personally, I’m looking at where you can find peak (or peaky) pandemic and the impact of high cashflows on capital structure. The former is a human tragedy but an investor opportunity. The latter implies looking at EV not market cap.

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