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.