A Funhouse Mirror Through Beer Goggles

If you fail to adjust your lenses to account for the ongoing drift away from “normal,” you risk being aggrieved at virtually every turn.

I try to make that point at regular intervals. It never matters. There’s a (large) contingent of market participants who, more than a dozen years later, refuse to admit that the “state of exception” (as Deutsche Bank’s Aleksandar Kocic called ultra-accommodative monetary policy) is permanent. Price discovery, in the pre-GFC sense of the term, isn’t coming back. The ubiquitous “hunt for yield” will remain a fixture of markets in perpetuity. Central bank balance sheets will never be unwound, certainly not aggressively or entirely. And so on and so forth.

Now, market participants are compelled to take account of pandemic distortions too — another lens adjustment. In just 12 years, we’ve experienced two of the most dramatic events in the history of capital markets. The world isn’t the same and because the policy response to the GFC was never unwound, central bank action in the wake of the pandemic amounted to doubling (tripling and quadrupling) down on the same policies. Markets are now a funhouse mirror and our lenses are beer goggles.

Failing to come to terms with our distorted reality where everything (including and especially asset prices and the incoming data) is relative, increases the proportion of headlines with the potential to raise one’s blood pressure. Wednesday was a spectacularly hilarious example.

Joe Biden called the July CPI report “good news,” for instance. The irritable among you would immediately protest that there isn’t much that’s “good” about headline inflation running at ~5%. You might also note, as some analysts did, that despite the moderation in the monthly core print, price pressures seem to be spreading out, becoming more pervasive albeit less acute.

But this isn’t a normal world. After three consecutive months of what, if you didn’t know the context, would appear as terrifyingly anomalous upside inflation surprises, July’s figures did indeed count as a relief, despite the giant asterisk you might fairly place next to the top-line numbers.

“The Moderation Begins,” read the title of TD’s summary. “All in all, the headline data were quite strong, largely as expected, lifted by food as well as energy prices, but the core data showed significant slowing relative to the last few months,” the bank’s Jim O’Sullivan wrote, adding that although 0.3% MoM is “still strong by pre-COVID standards, and YoY readings remain high, the data should help the ‘largely transitory’ view.”

For whatever it’s worth, the Cleveland Fed’s trimmed mean measure moved just 0.1% higher, to 3% (figure below).

The spread between the two gauges narrowed, but remains very wide (purple bars in the figure).

“The details within the CPI release hint that the transitory influences are waning; most notably used cars and trucks which were effectively flat after an impressive three month run, apparel was flat and airline fares were -0.1% after being up +2.7% in June and +7.0% in May,” BMO’s Ian Lyngen and Ben Jeffery remarked. “In the event monthly gains in core inflation settle back into the +0.2-+0.3% range, the Fed will have been justified in their lack of urgency to address the initial reflationary spike,” they added, before noting that “a broadening of the categories of consumer cost pressures will be the next flashpoint.”

Meanwhile, Wednesday’s 10-year sale was a rousing success. “Wow!”, exclaimed Bloomberg’s Edward Bolingbroke, minutes after the sale stopped 3.2bps through, the most in nine years. The bid-to-cover, at 2.65, was well above average (2.47) and dealers took just 9.6%, the lowest since 2008. The indirect bid was a record. “What added to the mystery was a round of heavy selling just before the results were published, which may have persuaded some that the result was going to be bad,” Bolingbroke went on to say Wednesday. “From this, a heavy burst of short covering may have instantly exacerbated the post-auction move lower in yields.”

Whatever the case, ~1.34% doesn’t exactly scream “bargain” with inflation running at 5%. This is made all the more vexing for the “traditionalists” by the fact that, over the past 24 hours, the Senate set the stage for more than $4 trillion in fiscal measures between the bipartisan infrastructure deal and the Democrat-only budget framework.

Here again we’re forced to ponder juxtapositions that would seem nothing short of surreal as late as 15 years ago. Isn’t “reckless” fiscal policy supposed to be met with a bond market revolt? Where are the storied “vigilantes” of yore? On the eve of one of the largest fiscal expansions in US history, and at a time when the disparity between the economy and monetary policy has never been more glaring (figure below), demand for US debt is stronger than ever, apparently.

Incidentally, Esther George on Wednesday said the “time has come” for the Fed to dial back easing measures. She called for a “transition to a more neutral setting.” To quote one man’s worst public speaking gaffe, “We’re a long way from neutral,” Esther.

What about equities? Well, what about them? Stocks did what stocks do — namely, log new record highs. On the S&P and the Dow, at least.

And why shouldn’t they? After all, it’s all relative (figure below).

As Leon Cooperman put it last week, “stocks make all the sense in the word relative to bonds.”

During the same breathless rant, Cooperman was genuinely incredulous. “Let’s say nominal GDP, on a trend bases, grows at 4%, so that would imply a 4% 10-year bond,” he said, before continuing,

Ok, this year, I figure in the third quarter, nominal GDP is expected to grow at 13%, yet we have a 1.3% 10-year government bond rate. You’re an investor, you pay taxes, you keep 60% of the 1.3%, so that’s what? Call it 80bps. The inflation rate is running 4% or 5%. Bonds make no sense.

Just another market participant who hasn’t adjusted his lenses or else simply can’t countenance what he’s seeing through the beer goggles.

After assailing the Fed, he took on liberals. “[I’m] troubled by the shift to the left that’s taking place in the country today,” Cooperman lamented, before decrying “young people” who, very much to his chagrin, are increasingly disposed to favoring socialism over capitalism.

Those young people, Cooperman said, “don’t have a clue.”

Commenting during a speech to the Chautauqua Institution Wednesday, Raphael Bostic reiterated the Fed “will no longer preemptively raise interest rates in response to a ‘hot’ labor market because of fear that inflation will eventually be a result.” “Without actual data demonstrating that an inflationary problem has arrived and is likely to be sustained, we will allow labor markets to run their course,” Bostic added.

Poor Leon. The world just ain’t what it used to be.