The bear flattening impulse seen across global bonds to start the week felt ominous.

If we are, in fact, seeing a policy pivot from pro-growth to anti-inflation (as BofA’s Michael Hartnett put it last week), it’ll have ramifications for equities and risk sentiment more generally.

In short, we may now be beyond good reflation and into bad inflation.

“US equities are increasingly becoming negatively sensitive to rising inflation expectations, as prior ‘feel good’ acceleration higher in growth and inflation expectations at the start of year now turns into ‘bad-flation’ concerns,” Nomura’s Charlie McElligott wrote Monday.

When it comes to stocks, it’s the same old story for tech and growth. Higher inflation and rising bond yields bode poorly for duration-sensitive bond proxies and secular growth favorites, some of which dominate benchmark equity indices.

Now, though, markets need to consider the prospect that economically-sensitive sectors might too come under pressure given the read-through from policy tightening for growth.

“Cyclical value Russell 2000 is still positively impacted by rising inflation expectations [but] it’s trending the wrong way,” McElligott went on to say, noting that concerns about tighter financial conditions engendered by rate hikes could bode poorly for cyclicals to the extent overzealous central bankers stumble into a policy error in an effort to shore up their inflation-fighting bonafides amid a shrill cacophony of criticism.


“Higher energy prices have been a touchstone for those in the market expecting accelerating inflation will define the coming year and prompt the Fed into a hiking campaign earlier than previously presumed,” BMO’s Ian Lyngen and Ben Jeffery wrote. “We’re cautious of assuming any eventual flow-through from higher oil prices to core prices will occur quickly enough to fulfill such hawkish ambitions,” they went on to say, adding that “the combination of higher energy expenses combined with the fallout from the ongoing supply chain issues risks functioning as a tax on both consumption as well as corporate profitability.”

This was always the risk. Talk of a “brave new world” in which developed market central banks would countenance inflation overshoots in an effort to ensure a return to full employment post-COVID and, more generally, avoid a Japan-style descent into perpetual deflation, assumed policymakers were, in fact, brave.

Now that inflation is “realizing,” there are nascent signs of panic, which manifested Monday in a fairly dramatic bout of bear flattening, led by gilts.

Nothing ever goes completely according to plan. Apparently, developed market central banks were hoping for consistent, benign inflation overshoots that persisted for, say, six or eight months, before gradually abating as pandemic effects rolled off.

Instead, they’re staring at large overshoots precipitated by factors beyond their control, the most obvious of which are supply chain disruptions and a spiraling global energy crisis.

The risk is that central banks overcorrect in a characteristically hapless effort to placate critics, committing a policy error in the process by tightening into a slowdown.

Importantly, there’s no guarantee that rate hikes will bring down consumer inflation expectations. Once again, central banks lack the tools to achieve their goals.

It’s becoming clearer and clearer over time that monetary policy simply doesn’t have the capacity to effectuate the outcomes it’s tasked with facilitating.

For a dozen years, central banks pushed on a string in a mostly futile effort to reflate the real economy. Now, in the pandemic era, they may discover that their purportedly “powerful” tools are inadequate to rein in real world inflation when it finally shows up courtesy of an exogenous shock.

In both cases, their tools were inadequate. Notwithstanding how effective they were at inflating financial assets.


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7 thoughts on “‘Bad-flation’

  1. Let me start by saying I don’t want to sound like a conspiracy theorist.

    That being said, the fed is run by some very well educated people with claims on being smart/astute.

    They are aware of the side effects of their tools (namely asset price inflation and the effect it has on the bulk of America). They are also among the richest people in our country with connections, both personal and professional, to other incredibly wealthy individuals and corporations. Those individuals and corporations are much better off (financially at least) in large part due to fed policy.

    If the fed toolbox is ineffective at combating the outcomes it’s tasked with are we to assume fed officials are oblivious to this? If they are not, why would they persist in this charade?

  2. Perhaps I am oversimplifying but it seems to me the labor “shortage” caused by millions of at least temporary labor force participation dropouts is a primal cause to the supply chain mess. Hundreds of thousands of unloaded containers rest off shore because our docks need workers to unload them, extra shifts in which to do the unloading and truckers to get the goods on the roads. The industry needs tens of thousands of experienced truck drivers to get the show on the road. It seems to me that folks are dropping out not because the Democrat socialists are giving them incentives to stay unemployed. That’s over and still we have 6 mil that used to be in the LF, and expected to return, who don’t really seem interested. They are more willing to “bet on themselves” and do gig work when they need some money. I think people are just tired of working. Truckers, production workers, construction workers, service providers and other such laborers can’t work from home, as they see their neighbors doing. What they have to do is real, often difficult and mostly inflexible. People want something else and seem to be willing to wait to find out what that something is. Trump did nothing concrete for these people. Meanwhile our country is degrading at an ever increasing rate, socially, in its infrastructure, and most of all in its character. Seriously, a huge proportion of our sitting Federal Judges (lifetime job, by the way — can’t be fired) are engaging in insider trading, getting rich and trying to pretend that someone else is actually doing this, they had no knowledge it was going on, and they will seek options to phase out this type of behavior real soon now. Increasingly, most our leaders are engaging in criminal acts, prevaricating, dissembling, and generally passing the buck while blaming others for their misdeeds and getting rich at our expense (at least the third of us who actually pay our taxes). The US is a hot mess of greed, selfishness, and generally bad behavior. We are no longer global leaders of anything in any sense (except maybe in self-delusion).

    1. Perhaps the decades of devaluing labor and reducing its power and benefits have finally hit home for those expected to maintain the supply chains. Executives have gotten incredibly wealthy and have been held to no account and yet “we” (the royal we) expect laborers to sacrifice themselves on the altar of capitalism to earn meager wages and die younger than they should. By the way, using the term “Democrat socialists” is very Fox Newsy of you and it also reveals how politically wired you are in your thinking. I say this not to counter strike but to perhaps provide you with you a mirror so that you can reflect on if you want to be a programed robot of corporate media or actually think for yourself and not be a pawn to the billionaire class.

      1. cdamworth: IMO your critique of Mr Lucky’s comments is completely misplaced.

        Seems you’ve misconstrued implications of his use of the term Democrat Socialists; i fault him only for failing to put that much-exploited phrase in quotes, as you’ve done.

        His commentary throughout and especially in his final sentences is spot-on. Nothing there reveals any latent Fox-indoctrinated analysis. You need to reread what he’s written in that revised context w/ the suggested added “”.

        Then maybe even offer an apology for so completely misconstruing his intent and the depth of his analysis of this as a flailing/failing nation; one seemingly hell-bent of self-destruction that will benefit only the very few, and not, as he also observes, its so easily-led neo-serfs

  3. Damned if you do damned if you don’t, I’m not sure how the Fed and other central banks get out of the mess they helped create without actual support from the fiscal channel, sadly that looks less likely by the hour. I can trade a bear flattener, a bull flattener or any rate expectations combo, chances are I’ll be fine regardless, but it is truly disheartening to see the lack of courage from our legislators and the real possibility of a policy mistake by the Fed, nothing will change, they’ll engineer a recession and we’ll have an inverted yield curve again in 3-4 years, so much for change. With no inflation, reflation or spending perhaps Manchin will be happy in coal infested WV, with deflation rampant again and folks poorer than they used to be.

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