Stagflation Week (Losing The Plot)

The market’s stagflation obsession will be on full display this week as GDP reports out of the US and Europe are parsed for signs of deceleration in an environment of acute price pressures.

On Thursday, data will show the world’s largest economy expanded at a markedly slower pace in the third quarter, following rapid growth over the previous two three-month periods.

Consensus is looking for an annualized 2.8% on the headline print (figure below). Given the perceived relevance of any and all incremental information, Friday’s personal income and spending figures for September won’t be entirely superfluous.

A sharp slowdown is “‘excusable’ insofar as the impact of the Delta variant is a key driver,” BMO’s Ian Lyngen and Ben Jeffery said. Still, they added, the deceleration “is meaningful as investors begin positioning for the balance of the year.”

At this juncture, the “peak growth” narrative has quite a bit of buy-in among market participants. Expectations for global growth, profits and margins all sank in the October vintage of BofA’s Global Fund Manager survey, for example. The growth outlook turned negative for the first time in 18 months.

When juxtaposed with rising yields and falling yield curve expectations (in the BofA survey, at least), the stagflationary vibe is perceptible indeed.

“Recall at the beginning of 2021, the assumption was that H1 was expected to be a solid showing, but the reopening process was seen propelling the US economy even higher during the second half of the year,” BMO’s Lyngen and Jeffery remarked, before noting that “with the GDPNow tracker at just +0.5%, the prospects are dwindling that Q4 will offset the Delta impact [while] elevated consumer prices into the holiday spending season presents a new set of risks, especially as the run up in the energy complex sets the stage for further sticker shock at the pump.”

That’s not exactly a favorable macro conjuncture, and it raises the risk of a Fed policy mistake, especially to the extent rate hikes are ineffective at combatting cost-push inflation.

Much of the market debate is playing out at the front-end, for obvious reasons. The tables (below, from TD) show the evolution of the recent price action as well as market pricing for rate hikes and the terminal rate.

“While magnitudes have varied across regions, the common theme amid the rise in front-end rates is the market’s expectation for higher inflation and faster central bank exits from accommodative monetary policy,” analysts led by Priya Misra said. “The strength in inflation has in part been due to global supply chain disruptions and the rise in energy prices, with investors starting to question whether these disruptions may persist for longer than initially anticipated.” The bank was stopped out of a five-year Treasury long last week.

This is playing out amid an ongoing effort to trim the White House’s social spending plan in order to placate moderates, where “moderates” just means Joe Manchin and Kyrsten Sinema. I’d say the plan is unrecognizable at this point, but as it turns out, American’s never knew what it looked like in the first place. As Bloomberg dryly wrote, “Joe Biden’s signature economic plan is suffering from a branding problem: Americans aren’t sure what it would do.”

“As we approach the mid-term elections of 2022, the prospects for growth would diminish as comprehensive fiscal stimulus comes in question,” Deutsche Bank’s Aleksandar Kocic remarked, in his latest. “In that environment, even if we see the signals for rate hikes, the Fed might choose to remain more gradual in order not to interfere with growth.”

Panning out a bit, you could pretty easily argue that market participants have simply lost the plot — that there’s too much ambiguity around inflation, growth and policy.

BMO’s Lyngen called that the “most snarky” take. “The market has simply lost context for the implications of reflation, the fallout for the real economy and the limitations of monetary policy in addressing systemic shocks such as those created by the pandemic,” he wrote late last week, noting breakevens at eight-year highs on the way to saying 10-year reals near -100bps “speak to the underlying growth concerns in an environment during which upward pressure on consumer prices threatens to undermine what was expected to be the most robust stage of the recovery.”

Also on deck in the new week, a bevy of housing data including Case-Shiller and new home sales. If it’s clarity you’re looking for, you won’t find it in the US housing market, that’s for sure.

Rounding out the data docket: Consumer confidence, durable goods, ECI, the final read on University of Michigan sentiment for October and, of course, claims.

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