If you ask the sell-side’s most famous bear, the bond market’s insufficiently attentive to inflation risks from what I’ll euphemistically call “recent events” in the Mideast.
On Thursday, oil prices rose and loitered near $100 amid “fire and fury” in the Persian Gulf, where tankers sat ablaze and residential towers were parking places for Shahed drones.
In a defiant first speech as Iranian Supreme Leader, Mojtaba Khamenei said the IRGC intends to keep the Strait of Hormuz closed and will continue to target US military installations in the region, suggesting little in the way of respite for Americans who’ve already seen enough in the way of higher gas prices.
“Investor expectations of five-year inflation, five years from now [have failed] to respond to the sharp rise in oil prices,” Edwards wrote. “This is odd, bordering on bizarre, because there’s normally a pretty good short-term correlation between the two series.”
As a quick aside — and Edwards did mention this — one- and two-year inflation swaps have reacted to the oil drama. For example, the one-year swap rate hit 3.11% early this week, which constituted the first foray above 3% in five months.
Whatever he doesn’t know, Albert does know bonds. And in my estimation anyway, he’s justified in suggesting that 10-year US nominal yields at 4.20% (4.25% as of noon Thursday) aren’t priced for a continuation of what we’re seeing in the Gulf.
Consider that 4.25% on 10s just gets us back to early February levels. The cycle high, recorded during an infamous bout of turmoil in late October of 2023, was north of 5%.
“Investors believe that any upward blip in inflation will be short-lived and US rate cuts are delayed but not cancelled,” Edwards said, adding that it’s also possible market participants are betting an AI-driven productivity boom will cap inflation over the medium-term, whatever happens in the near-term.
I don’t love the 1970s stagflation analogue mostly because when ostensible historical parallels become as ubiquitous as that one is, they tend not to pan out for the same reason crises everyone anticipates have a hard time materializing.
Still, I’ll indulge the chart under the circumstances. You know the chart I mean. If not, here it is:
“To the extent more rapid productivity growth is suppressing unit labor costs, that will drag CPI inflation lower, all else being equal,” Edwards said, before quickly cautioning that “all else isn’t equal right now.”
He went on to remind investors that he’s long anticipated a second inflationary wave, but said the oil spike means it “could hit sooner.” “I’m not sure of that,” Albert wrote. “But I am sure the market seems strangely complacent.”
Cue the ominous music and thunder sheets.
Unlike the previous oil price spike, this time TACO can and will come to the rescue if this goes on for longer than several weeks.
I’m not so sure. The Iranians aren’t known to ‘ACO, and neither are the Israelis
Trump no longer has any control of an off ramp. The course is set. The IRGC has been preparing for this for decades.
During the first spike, people were stuffed with stimulus money. That since evaporated, so would expect people to sooner cut expenses than just continue to go all out like during the first spike?
Is Mojtaba Khamenei still alive? Is he capable of creating this statement? “His message was broadcast on Iranian state TV, but Khamenei did not appear in person. His message was instead read out by a newsreader.”
“Is Mojtaba Khamenei still alive?” Who knows.
“Is he capable of creating this statement?” Yes. At least if by that you mean is he someone who can write like this. He has more religious credentials than his father did when he took over. He’s no Fredo.
“Khamenei did not appear in person.” This doesn’t matter. I wouldn’t let anyone film me either right now.
But, again, your main question as to whether he’s actually alive is, I think, a good one. I’d put the odds at 85:15 he’s alive.
Edwards’ style is not overly attentive to high-frequency economic indicators.
Put plainly: if LLMs don’t plateau soon, if the subsidization of inference doesn’t stop soon, then the disinlationary effects of AO could add more than enough slack to compensate for oil pricing. Top-line inflation may fall.
Edwards is not wrong, just presbyopic (and what is the long term oil price path anyway? Russia and Iran can’t hold out forever and our missile supply is limited.)