These Are Why tech Stocks Are Dropping .There’s one story that’s dominating trading floors today, and that’s how far inflationary pressures can impact bond yields and what effects are rising bond yields will have on risk assets.
The inflation signals continue to build across several assets.
Speculative positioning in copper futures is at an all-time high, but this hasn’t stopped copper prices from being propelled back towards the highs of the last 20 years. Crude oil futures have regained pre-pandemic levels despite demand remaining sluggish.
This has helped the energy sector win back some of last year’s underperformance vs. the tech-heavy Nasdaq.
While the steepening yield curve has fueled banks’ outperformance against the same index in what could be a topping formation that favors more outperformance by the banks.
The drive higher in bond yields has been pushing real yields higher too, which has been one of the main culprits of the recent underperformance of gold. If we look at the copper versus gold ratio compared to the U.S. ten-year yield, it suggests those yields should be headed much higher.
But first, there’s some significant resistance to overcome around the 145 to 150 percent level.
In simple terms, things have been moving pretty quickly on the inflation front. But how real are these inflationary pressures? Is there a danger that inflation is just a mirage of weaker U.S. dollar and extreme positioning by active managers who’ve been happy to chase for momentum?
For owners of assets that negatively correlate to yields and inflation, it doesn’t matter whether inflation is real or not, if the market prices for it anyway.
In The Big Conversation, we’re going to look at charts that help contextualize this inflationary backdrop and whether we should be worried that the reflation trade could become a victim of its success.
Investors have been steadily increasing allocations to commodities and short-term government bonds as hedges against rising inflation. This is even though central bankers remain relatively sanguine about inflation risks, which they see as weighted to the downside.
Markets, however, are taking a different view, having pushed five-year inflation expectations to the ten-year highs. But why does this matter? Clearly, given the massive levels of private and public debt, any underlying event that forces the Fed’s hand in raising rates could have significant implications for a still-fragile global economy.
The market is starting to bring forward its expectations of rate hikes with the December 2023 Eurodollar futures were selling off this year. Now it’s still some way off, but the shift is building momentum, and the path to pricing inflation could involve rotations out of many long-term winning sectors like tech and investment standard corporate bonds.
If policymakers aggressively confront the inflation genie, it could well abort the economic
recovery and plunge the world back into a global recession.
But getting behind the curve could mean more inflationary pressures and risk significant yet
capital losses for bond market investors, which today also includes the many holders of bond proxy assets in the equity market.
Today, there is a far more outstanding stock of assets that could follow bond prices lower.
Today’s inflationary fears have been stoked by figures such as former Treasury Secretary
Lawrence Summers and former IMF chief economist Olivier Blanchard have noted
the current high rate of U.S. personal savings.
The amount that Americans have in their savings spiked for two reasons – the inability to
spend discretionary income due to Covid related shutdowns and the fiscal relief transferred to households under the CARES Act. Households, in theory, at least, are chockablock with spendable cash. But this cash may not be evenly distributed.
We know inequality has increased again, and it may be that the cash is being held as a
buffer against future risks because the eventual reopening of economies will also see an end
to debt holidays and a return to settling invoices in full. But how real are accurate global inflationary pressures? Inflation expectations may have picked up across the world, but the pace is not even.
The difference between European and U.S. forward inflation expectations is close to historical lows.
Europe’s increase in expectations has lagged far behind that of the U.S. But even in the U.S., the potential for inflationary pressure is probably overstated if we distinguish between actual savings and opportunistic savings, where opportunistic savings could be used to offset debts elsewhere. American middle-income households again went into a crisis with high levels of credit card, student, and auto debt. Although overall household debt to GDP looks to have fallen, it again reflects the uneven distribution between the haves and the have nots.
It’s easy to forget now that the global economy was not in a strong position before the pandemic.
Growth has been patchy, and capital has been allocated towards asset prices rather than
And if the excessive savings are not going to be used to reduce household debt, then
reversing that process will require two things; a high level of consumer confidence, which
historically has helped to drive up additional debt accumulation, and also job and household
income levels that induce lenders to lend. Concerning consumer enthusiasm, the Michigan Consumer Sentiment Index was down again this month at 76.2 from 102 pre-pandemic. Household incomes are in an unhealthy state.
If you ignore federal transfers, consumer lenders don’t tend to lend to households trying to make ends meet through government subsidies. Of course, there may well be some inflationary bottlenecks as people normalize their lives and seek services they’ve missed out on for a year or more, particularly across the entertainment industry.
But a Steven Blitz, chief economist at T.S.Lombard, put it recently “to those anticipating big
reopening related surges in prices…perhaps the surge will be more evident in Michelin
starred restaurants than in the local diner.” And are market expectations realistic given the prevailing economic weakness in other parts of the world or at least the far lower inflationary enthusiasm levels being priced into other regions?
And its most recently published minutes, the ECB policymakers committed to keeping a steady
hand on stimulus measures, promising to disregard any short-term jumps in inflation.
The ECB is also paying little heed to the existing inflation data, which showed headline
consumer price inflation hitting an 11 month high of 0.9% in January, up from -0.3% in
December, according to a flash estimate published by Eurostat in early February.
A combination of one-off factors drove this fastest jump in more than a decade
rather than a revival of underlying demand.
Because many of the bloc’s shops, schools, and leisure venues remain closed through this
Period. The reversal of a temporary reduction in German value-added tax at the start of this year
played a role, as did higher energy costs and supply chain disruptions that have raised
container shipping prices for retailers and manufacturers. Thus, inflation is mainly due to bottlenecks.
Sustained European inflation is still well short of the 2% target, and sustained is the
keyword here. We saw inflation rebound after the great financial crash, but it could not hold onto those initial highs. European price pressures have also been buttressed by huge fiscal support packages that have slowed down the pace of bankruptcies that had initially accelerated in the second quarter of 2020.
If capital is being used to keep businesses on life support, then it doesn’t have a great
deal of future inflationary potential. The problem is that once there is a return to some form of normality, these support packages will end. Repayments will be demanded on many of these loans that have been implemented to prevent corporate bankruptcies, which could well intensify deflationary pressures in Europe. In other words, Europe is a breeding ground for deflationary pressure. And what about China?
As most nations worldwide have struggled with new lockdowns and layoffs in the face
of the surging pandemic, the Chinese economy has bounced back after bringing the Coronavirus mostly under control. The Chinese economy rebounded 2.3% at the end of last year, the country’s National Bureau of Statistics announced in January. And there’s always a great deal of cynicism around these data points from China.
But in the short term, it serves a point.
While the recovery remains uneven, factories across China are running on overdrive to fill
overseas orders and construction sites are busy again, reflecting a boom in exports and
debt-fueled infrastructure investments that are expected to drive the economy during the
the coming year, including through the Communist Party’s 100th-anniversary celebrations in
This is one of the reasons why we’ve seen a surge in commodity prices in the last few
months, with global demand for copper being led by China, where Shanghai inventories are
also at the bottom of their multi-year range.
As far as Chinese growth goes, it’s worth noting that much of that growth is being directed
towards reestablishing global supply chains that were disrupted throughout 2020 as a consequence of Covid-19.
As these supply chains are reconstructed, they will effectively eliminate many of the
bottlenecks that have led to upward pressure on prices.
Therefore, can we have global inflation that is predominantly only really being priced in the U.S.?
China’s ongoing state activism means that they will continue to finance CAPEX overcapacity
through their state-owned enterprises, which will generate more deflation in the West.
The economic and political lifeblood of China remains highly dependent on continued investment
to ensure the state remains front and center in the economic sphere by propping up the
SOE’s and the state-owned banks.
And that objective imparts a strong deflationary bias to the global economy. The implications for the U.S. are that any wage inflation gains are likely to be transient at best.
Businesses will lean against wage pressure by cutting back hours or simply refusing to
take on more workers to preserve profits, including stock prices and CEO compensation.
All of this suggests that the global inflationary story is still one of the bottlenecks rather