Topic Du Jour

Topic Du Jour

Headed into the June Fed meeting, analysts and strategists were keen to dissect last week’s “counterintuitive” action in rates which, on the face of it anyway, seemed demonstrably at odds with another hot read on inflation stateside.

By now, most serious traders and investors can offer some version of a plausible explanation for the current conjuncture, which finds 10-year US yields hovering below 1.50% despite the surge in realized inflation and an optically scary jump in consumer expectations.

The simple figure (below) shows… well, it just shows what it says it shows. Core CPI and PCE versus year-ahead expectations from the University of Michigan’s sentiment survey.

The market’s topic du jour is the disconnect between that (the upswing) and bond yields, which fell the most in a year last week. Note that while the figure shows the YoY prints for CPI and PCE, MoM gains clearly demonstrate base effects aren’t the only problem.

If you ask Morgan Stanley’s Mike Wilson, yields are reacting to what the market sees as “peak rate of change” for inflation.

“While all of these measures have moved sharply higher, they also appear to have peaked from a rate of change standpoint with the shorter tenures of the breakevens markets rolling over the hardest along with consumer expectations,” he said Monday. “The point here is that just like with many of our growth measures, it appears that the peak rate of change for inflation may be behind us.”

That’s good news from an “inflation scare” perspective, but what might be missing from the narrative is any hint that the economy could underwhelm. It’s all about “overheat” risk, but as Wilson remarked in the same note, the reversal in nominals and breakevens “could be an early signal that both growth and inflation may start to disappoint what are now lofty expectations.”

Although Morgan still projects robust growth, Wilson said demand in the first quarter was “extraordinary,” and doubts it’s sustainable. He cited fiscal stimulus, of course, but also crypto.

“The culprit in our view is a first quarter level of demand that was aided by $1.9 trillion fiscal stimulus and a rise in crypto currencies that added another $1 trillion to wealth,” he remarked, noting that “neither one of these are likely to be repeated in our view.”

At a more granular level, Nomura’s Charlie McElligott documented the beginnings of the squeeze, as (partially) revealed in CFTC-CoT, Fed and TFF data. He flagged “massive buying… with overall Non-Comm Spec adding $18.3 billion of USTs [during] the last weekly reporting period.” Delving into the details, Charlie said that,

Macro / Leveraged narrative- and positioning- having been so short, and critically, with trades getting increasingly expensive to hold from Theta- / Carry- / Roll- perspective and most expressions underwater since March—thus the obvious “unwind” flows over past 2w; Asset Managers known to be so underweight Duration YTD and thus net bot $15mm / 01 last week (with majority as “New Longs” not short-covers, and most Net since April of this year); Pensions now achieving fully-funded status and needing to buy fixed-income and de-risk, which looks to be the case with Treasury stripping activity making new all-time highs; and Foreign buyers increasingly seeing very attractive FX-adjusted yield pickup at 5-6 yr best levels, with the largest weekly demand in Fed Custody Holdings over the last weekly period since mid-March.

All of this literal buy-in is conspiring with (and is in part motivated by) figurative buy-in to the Fed’s “transitory” talking points, which officials have spent the last several months bludgeoning market participants half to death with.

Weighing in Monday morning, BMO’s Ian Lyngen noted that while “the most recent CoT data shows net spec positions in TY are at the longest since Oct 2017,” there’s no uniformity here. “Futures positions in FV, US, and WN all remain significantly short, even if slightly pared back from recent extremes,” he said, before ultimately suggesting that the “combined shifts are more consistent with scaling back from a core-short position as opposed to a wholesale capitulation and abandonment of the reflation trade.” One way or another, he added, there’s “no question that positions were responsible for a portion of the recent bid for Treasurys.”

If I were in the business of drawing conclusions (which I’m clearly not, as I usually raise far more questions than I answer in these pages), I might casually suggest that positioning is now “cleaner” into the Fed, allowing onlookers to take the market’s reaction to the statement and press conference at face value. (Insert chuckle.)


4 thoughts on “Topic Du Jour

  1. “…it appears that the peak rate of change for inflation may be behind us.” As a net importer, the US is a lagging indicator. I’m sure our company isn’t the only B2B raising prices. It’s supply chain inflation. Transitory? Maybe, but supply chains notwithstanding, there are other sources of inflation (on-shoring, shifts in priorities for raw materials vis-a-vis green energy, trade friction w/ China, et al.

    “…and a rise in crypto currencies that added another $1 trillion to wealth,” he remarked, noting that “neither one of these are likely to be repeated in our view.” As if that “wealth” wasn’t based in a zero-sum game. That “wealth” is (ostensibly) realized only after conversion into fiat currency such as USD. There is a counter-party to that transaction. Just saying…

    1. I don’t understand why purchasing managers can’t provide a reasonably accurate prioritized list of what’s driving supply chain shortages and delays. If the forces can have such a large effect, they should be easy to identify. I thought the free market’s strength is to quickly resolve such situations. If the supply chain deteriorated in 15 months, how long can it take to straighten out? I mean how bad could the problem be – get people to go back to work, especially for raw materials, unless those at the bottom of the pay scale are more important than their wages suggest.

      1. When cattle ranchers cull their herds significantly it takes 18-24 months to get saleable output back to normal. Crops not planted generally can’t be brought back to normal output in less than a year. Last year, for example there was a huge crash in the amount of vegetables available for canning. When the fall 2020 crop was canned, no more could be had until this year’s crop so cans were held back to flatten sales. Most commodities are available in cycles that are hard to restart once broken. I ordered a home generator in late September 2020. None were available in the US. I put one on order at Home Depot and never did hear back. I lucked into one in mid-April at another store and it was finally able to be installed 10 days ago. No parts, no shipping capacity, constrained capacity for unloading parts in US ports are all part of the problem. The flaw in the practice known as just-in-time (JIT) supply chain practice is that unless someone, somewhere has a bunch of inventory a break in supply will take months to fix. Hence constrained car production. No chips, no cars (chips are “B” items in inventory parlance — not expensive but irreplaceable). No new cars to sell means no used cars in trade so used car prices up. Now just a waiting game. Hey there is toilet paper again and my favorite baked beans are on the shelves again for the first time in like six months.

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