A Summer Lull
Summary: US equities were mixed overnight whilst the dollar fell, and treasuries held steady. Markets continue to range trade with low energy, and low volumes. Its a waiting game ahead of China PPI data, US inflation data on Thursday and beyond that a lasting test on whether the market can continue to buy the transitory narrative.
The Fed continue to spruik in a coordinated fashion the transitory nature of current price pressures, however the evidence is stacking up that transitory may be an extended period and may not be so transitory after all. It is difficult to believe the market will be so patient if inflation continues to print to the upside. We remain sceptical not only of the assertion that price pressures are transitory but also of the Fed’s commitment to stay the course. A Fed pivot looms and the probability the Fed may signal a shift toward tapering of its asset purchases is rising. For now, our money is still coalescing around Jackson Hole as a potential signalling forum for the impending policy pivot surrounding the pace of liquidity provision. Yellen’s commentary earlier this week clearly an attempt to prepare the ground for this shift.
Last weeks miss on the US jobs data has been viewed as a “goldilocks” print, allowing markets to run high on the cool aid that the labour market is recovering, but not to a degree that the punchbowl of liquidity will soon removed. Large caps loved the softer data, but we sense complacency as the balance of probabilities continue to point to further price pressures, a recovery in the labour market that is gathering pace (additional UI rolling off from June in 24 States) and a Fed who will find their position increasingly difficult to justify. And not inconsequentially, the irony is the longer the punchbowl remains in play, the further inflation expectations can climb.
In the US renormalisation continues and the path to more persistent inflation remains open as supply remains constrained with demand rebounding, pandemic fatigued consumers flush with “stimmy” cheques and savings are ready to spend (in the US the poorest quintile of households - the cohort most likely to spend - have seen ~20% boost to annual incomes). The combination of the two a melting pot for price pressures and visible across the goods and services economies as reopening’s continue. Wage and price expectations could well shift higher during this upcoming period of price pressures. Even if the initial kicker is transitory – the lasting impact may be less so. And in terms of read throughs for asset pricing the definition of transitory comes into question.
The latest readings on inflation expectations are sitting in the upper spectrum of the range seen in recent decades, and with pent up demand in play price hikes could be relatively sticky, embedding inflationary psychology. The University of Michigan's survey of inflation expectations surged in May. The measure that gauges near-term inflation expectations pushed to 4.6% from 3.4%. Expectations in many ways are a self-reinforcing feedback loop for future inflation - if business and consumers expect price increases in the future, they will be more willing to pay up today. Both market and consumer expectations of inflation have picked up and soon the Fed will have to take note, monetary policy remains in crisis mode – a stance that will be increasingly hard to justify. Particularly if the labour market continues to recover through the summer as some 24 States end the additional $300/week enhanced unemployment benefits and school reopening’s continue, promoting increased return to work. In short with further price pressures filtering through as the macro recovery continues, the reflation trade should have room to run, supporting positioning for higher inflation, commodities and value/cyclicality/economic sensitivity/reflation orientated sub sectors of risk assets. With US yields eventually pushing higher in tandem with the aforementioned dynamic, post this period of consolidation.
That said, there remains a lot of noise and unknowns when it comes the interactions of the COVID-19 crisis and stimulus response with the global economy and mass human behaviour. Although we think it is probable to see higher and more persistent inflation, we do not have all the answers and it is perhaps still too soon to draw decisive conclusions. However, from a portfolio standpoint the risk of higher inflation must be accounted for – its no longer a one-way bet. Longer term structural shifts toward fiscal dominance and climate change mitigation could well counter the disinflationary spiral of debt, demographics and disruption that has shaped the last decade.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.