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Weekly Market Pulse: Inflation Scare?

Bonds sold off again last week with the yield on the 10 year Treasury closing over 1.6% for the first time since early June. The yield is now down just 16 basis points from the high of 1.76% set on March 30. But this rise in rates is at least a little…

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Bonds sold off again last week with the yield on the 10 year Treasury closing over 1.6% for the first time since early June. The yield is now down just 16 basis points from the high of 1.76% set on March 30. But this rise in rates is at least a little different than the fall that preceded it. When nominal rates fell from April through July, real rates fell right along with them. The nominal bond yield fell by 63 basis points and the 10 year TIPS yield fell by 57. That means that the drop was driven by a change in real growth expectations not a change in inflation expectations. But the rebound has not been as uniform, as the nominal rate has risen by 47 basis points while the real rate has only climbed by 27. So, this rise has been driven more by rising inflation expectations than rising real growth expectations, although there has been some of both. But last week’s 14 basis point rise in the nominal rate was all about inflation – TIPS yields were unchanged. The weak employment report last week got all the news but the bond market was focused like a laser on average hourly earnings and the potential that has for inflation. The difference here is not large and inflation expectations at the 10 year time frame are still just 2.5%. That is higher than I’d like but compared to the last 20 years is not extraordinary.

Maybe TIPS rates will catch up to the rise in nominal rates and none of this will mean anything but if rising inflation expectations turn into rising inflation that turns into a further rise in inflation expectations, well then, Houston we have a problem. I have said before that we won’t get sustained inflation without a fall in the value of the dollar and I stand by that. Historically, inflationary periods have also been weak dollar periods. And inflation expectations tend to rise when the dollar is weak and fall when the dollar is strong:

10 year Breakeven inflation rate and the inverse of the broad dollar index:

I think there is a question though as to the direction of causation. Does a weak dollar create inflation or does inflation cause the dollar weakness? I think we all think back to the end of Bretton Woods and think it must be the former but I’m not at all sure about that. During the Bretton Woods era inflation fluctuated pretty wildly after WWII (10% in 1948) as the Fed held rates low to keep interest costs on the war debt low (sound familiar?). The dollar didn’t move because exchange rates were fixed but if it could it probably would have since the Fed kept rates from doing so. And inflation did rise from roughly 1% in 1965 to over 6% by 1970 and the pressure on the dollar eventually pushed Nixon to break the peg to gold in August of 1971. In any case, the dollar right now remains in a short term uptrend within a narrow trading range that has persisted for nearly 7 years:

The rise in rates is not confined to the long end of the curve as the 2 year yield is rising too but the long end is rising faster so the yield curve is also steepening. There is still quite a ways to go if the curve is going to steepen to the point it has after the last few recessions:

While a steepening curve is associated with economic recovery, the steepening we’ve seen in past cycles was driven by falling short term rates rather than rising long term rates. That is obviously not the case this time but whether that makes a difference is something I don’t know. If the steepening of the curve induces recovery then this is indeed good news. That could be the case if a steeper curve induces more lending by banks but loan demand may be as much a problem as supply.

While the current inflation rate may not be sustainable (if the dollar stays strong) that does not mean the current price hikes will be reversed once the supply chain is cleaned up. Average hourly earnings in the latest employment report were up strongly, 0.6% for the month and 4.6% year over year. But real average hourly earnings (after inflation) were not, up just 0.1% for the month and down 1.1% over the last year. Even if this inflation is “transitory”, companies are going to do their best to retain the price hikes of the last year. Commodity prices should be an exception but environmental policies are making that less likely. The push for net zero emissions from traditional energy companies means they aren’t investing to discover new reserves. Banks have been pressured to not lend to fossil fuel companies and the Fed is being pressured to make that more than a suggestion through capital requirements. That is the obvious implication of adding a climate mission to central banks remit. There’s a reason oil and natural gas prices are where they are and I do not expect the supply side to get better anytime soon. And reducing demand isn’t merely a matter of building more windmills and solar farms as Europe and the UK have discovered to their citizens dismay. 

The employment report released last week was obviously not what everyone wanted but I wouldn’t put a lot of emphasis on it. The August figure that was so disappointing last month was revised higher by 131,000 and I wouldn’t be surprised in the least if that keeps getting revised higher. As for the September figures, I don’t think the end of the extended and enhanced unemployment benefits was fully reflected. The survey for this report was conducted just a week after the benefits ended. Let’s see how it looks in October and how the September figures are revised. I, for one, have no idea whether the end of those benefits will have a large impact. What I do know is that the labor market is changing significantly and it isn’t over by a long shot. And we have no idea whether these changes will prove beneficial or detrimental to the economy or society as a whole.

The inflation we see today is a consequence of past policy choices but I don’t mean, necessarily, monetary policy. Our response to this pandemic was straight out of the demand side recession playbook. Unfortunately, it wasn’t a demand led recession but rather a supply shock (mostly). It should not be surprising that prices are rising. Stimulating demand before the supply side recovered was a recipe for disaster and here we are. I suppose the pandemic response may have reduced the pain of the recession and it may have even reduced the depth of the economic loss. But there are no free lunches in this world and the cost will be measured in the recovery. We entered the pandemic with a trend growth rate of 2.2% over the previous decade. Higher prices and a large addition to our debt load point to a future trend growth rate that is even lower.

Whether that scenario comes true or not depends on a lot of factors that we can’t predict so it isn’t inevitable. In fact, I think there are hints that pandemic induced changes may well prove economically beneficial. The future is, as always, unknowable but it is surely going to be interesting.


 

For now, because the rise in rates is being driven more by inflation fears than growth hopes, I will not change my characterization of the current economic environment. We are still in a slowing growth, rising dollar environment:

 

Despite the disappointing employment report the economic news last week was actually pretty good. Exports and imports were both up, although exports are still lagging imports. The ISM services index was better than last month and than expected. It may be that the Delta slowdown in services spending is coming to an end.

 

It’s a pretty big week for data with more information on the labor market via the JOLTS reports and a slew of inflation indicators. We also get a preliminary look at Consumer Sentiment which has not been all that positive recently.

 

Stocks generally didn’t do that well with rising rates but commodities continued their outperformance. Real estate also isn’t liking higher rates although YTD performance is still impressive.

The value indexes though did perform well last week especially at the small and mid cap levels.

 

 

Value outperformed because those indexes are dominated by financial and energy both of which did extremely well in last week’s environment. Even after a huge rally this year, energy is still down over the last 3 years and barely positive over 5. There is probably a long way to go on that front if demand holds up.

 

Rates are on the rise mainly due to inflation fears but that could just be temporary. Changes in TIPS yields and nominal yields are often mismatched. We saw a similar dynamic in the previous rate rise from August to December last year. Eventually TIPS yields turned higher too and both peaked at about the same time. So, don’t get too excited about inflation or growth fears just yet. The inflation is obvious to everyone but any gains in growth seem to be still prospective. And it may be that we will need to see inflation fears fade before TIPS yields join the party. But I don’t think this business cycle is anywhere close to done so just be patient.

Joe Calhoun

 

 

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Huge Dock Worker Protests In Italy, Fears Of Disruption, As Covid ‘Green Pass’ Takes Effect

Huge Dock Worker Protests In Italy, Fears Of Disruption, As Covid ‘Green Pass’ Takes Effect

Following Israel across the Mediterranean being the first country in the world to implement an internal Covid passport allowing only vaccinated citize

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Huge Dock Worker Protests In Italy, Fears Of Disruption, As Covid 'Green Pass' Takes Effect

Following Israel across the Mediterranean being the first country in the world to implement an internal Covid passport allowing only vaccinated citizens to engage in all public activity, Italy on Friday implemented its own 'Green Pass' in the strictest and first such move for Europe

The fully mandatory for every Italian citizen health pass "allows" entry into work spaces or activities like going to restaurants and bars, based on one of the following three conditions that must be met: 

  • proof of at least one dose of Covid-19 vaccine

  • or proof of recent recovery from an infection

  • or a negative test within the past 48 hours

Via AFP

It's already being recognized in multiple media reports as among "the world's strictest anti-COVID measures" for workers. First approved by Italian Prime Minister Mario Draghi's cabinet a month ago, it has now become mandatory on Oct.15.

Protests have been quick to pop up across various parts of the country, particularly as workers who don't comply can be fined 1,500 euros ($1,760); and alternately workers can be forced to take unpaid leave for refusing the jab. CNN notes that it triggered "protests at key ports and fears of disruption" on Friday, detailing further:

The largest demonstrations were at the major northeastern port of Trieste, where labor groups had threatened to block operations and around 6,000 protesters, some chanting and carrying flares, gathered outside the gates.

    Around 40% of Trieste's port workers are not vaccinated, said Stefano Puzzer, a local trade union official, a far higher proportion than in the general Italian population.

    Workers at the large port of Trieste have effectively blocked access to the key transport hub...

    As The Hill notes, anyone wishing to travel to Italy anytime soon will have to obtain the green pass: "The pass is already required in Italy for both tourists and nationals to enter museums, theatres, gyms and indoor restaurants, as well as to board trains, buses and domestic flights."

    The prime minister had earlier promoted the pass as a way to ensure no more lockdowns in already hard hit Italy, which has had an estimated 130,000 Covid-related deaths since the start of the pandemic.

    Meanwhile, the requirement of what's essentially a domestic Covid passport is practically catching on in other parts of Europe as well, with it already being required to enter certain hospitality settings in German and Greece, for example. Some towns in Germany have reportedly begun requiring vaccination proof just to enter stores. So likely the Italy model will soon be enacted in Western Europe as well.

    Tyler Durden Sat, 10/16/2021 - 07:35

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    China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

    China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

    One week ago we discussed why the "worst case" scenario for China’s property crisis is gradually emerging; to this we can now add that China’s worst case energy crisi

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    China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

    One week ago we discussed why the "worst case" scenario for China's property crisis is gradually emerging; to this we can now add that China's worst case energy crisis scenario is also about to be unleashed as cold weather swept into much of the country and power plants scrambled to stock up on coal, sending prices of the fuel to record highs.

    Electricity demand to heat homes and offices is expected to soar this week as strong cold winds move down from northern China, according to Reuters with forecasters predicting average temperatures in some central and eastern regions could fall by as much as 16 degrees Celsius in the next 2-3 days.

    Shortages of coal, high fuel prices and booming post-pandemic industrial demand have sparked widespread power shortages in the world's second-largest economy. Rationing has already been in place in at least 17 of mainland China's more than 30 regions since September, forcing some factories to suspend production and further disrupting already broken supply chains.

    On Friday, the most-active January Zhengzhou thermal coal futures closed at a record high of 2,226 per tonne early. The contract has risen almost 200% year to date.

    China's three northeastern provinces of Jilin, Heilongjiang and Liaoning - also among the worst hit by the power shortages last month - as well as several regions in northern China including Inner Mongolia and Gansu have started winter heating, which is mainly fuelled by coal, to cope with the colder-than-normal weather.

    Meanwhile, even though Beijing has taken a slew of measures to contain coal price rises including raising domestic coal output and cutting power to power-hungry industries and some factories during periods of peak demand, so far all measures have failed with coal surging by 40% in just the past three days. Beijing has also repeatedly assured users that energy supplies will be secured for the winter heating season, and went so far as to order energy firms to "secure supplies at all costs." Well, the energy firms heard it, because on that day, thermal coal closed at 1,436 yuan. Two weeks later it is some 800 yuan higher.

    Unfortunately for Beijing, the power shortages are expected to continue into early next year, with analysts and traders forecasting a 12% drop in industrial power consumption in the fourth quarter as coal supplies fall short and local governments give priority to residential users.

    Earlier this week, we reported that China undertook its boldest step in a decades-long power sector reform when it allowed coal-fired power prices to fluctuate by up to 20% from base levels from Oct. 15, enabling power plants to pass on more of the high costs of generation to commercial and industrial end-users. read more

    Steel, aluminium, cement and chemical producers are expected to face higher and more volatile power costs under the new policy, pressuring profit margins.

    Meanwhile, the latest Chinese "data" on Thursday showed factory-gate inflation in September hit a record high; but since thermal coal is the one commodity that correlates the closest to PPI, absent a sharp drop in coal prices in the next few weeks, expect the next PPI print to be far higher. Meanwhile as the power crisis leads to further shutdowns in domestic production, some banks - such as Nomura - have gone so far to predict that China's GDP is set to shrink in coming quarters.

    China, which laughably aims to be "carbon neutral" by 2060 even as its president announced he will skip the COP26 UN Climate Change Conference in Glasgow, has been "trying" to reduce its reliance on polluting coal power in favor of cleaner wind, solar and hydro. But coal remains the source for some 70% of China's electricity needs.

    Of course, China is not the only nation struggling with power supplies, which has led to fuel shortages and blackouts in many European countries. and threatens to send US heating bills up as much as 50% this winter. he crisis has highlighted the difficulty in cutting the global economy's dependency on fossil fuels as world leaders seek to revive efforts to tackle climate change at talks next month in Glasgow.

    China will strive to achieve carbon peaks by 2030, Vice Premier Han Zheng said in a video message at the Russian Energy Week International Forum, according to state-run news agency Xinhua late on Thursday. He also said that China and Russia are important forces leading the energy transition and they should cooperate and ensure smooth progress of major oil and gas pipeline and nuclear power projects.

    Translation: Russia better save that nat gas and not ship it to Europe as China will soon be needed even BCF Russia an provide. As for China

     

    Tyler Durden Fri, 10/15/2021 - 22:50

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    Retail And Food Sales: If It’s Not Inflation, And It’s Not, Then What Is It?

    OK, so we went through the ways and reasons consumer price increases are not inflation, cannot be inflation, are nowhere near actual inflation, and what all that really means. The rate they’ve gone up hasn’t been due to an overactive Federal Reserve,…

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    OK, so we went through the ways and reasons consumer price increases are not inflation, cannot be inflation, are nowhere near actual inflation, and what all that really means. The rate they’ve gone up hasn’t been due to an overactive Federal Reserve, so it has to be something else. This is why, though the bulge has been painful, it’s already beginning to normalize. Without a persistent monetary component (in reality, not what’s in the media) the economy will adjust eventually.

    It already has. Several times, and that’s part of the problem.



    If not money, and it’s not, then what is behind the camel humps? No surprise, Uncle Sam’s ill-timed drops along with reasonable rigidities in the supply chain.

    An Economist might call this an accordion effect. One recently did:

    The closures and reopenings of different industries, coupled with the surges and lags in consumer purchasing during the pandemic, have caused an “accordion effect,” says Shelby Swain Myers, an economist for American Farm Bureau Federation, with lots of industries playing catch-up even as they see higher consumer demand.

    Not just surges and lags, but structural changes that have been forced onto the supply chain from them. With the Census Bureau reporting US retail sales today, no better time than now and no better place than food sales to illustrate the non-economics responsible for the current “inflation” problem.

    When governments panicked in early 2020, they shut down without thinking any farther than “two weeks to slow the spread.” This is, after all, any government’s modus operandi; unintended consequences is what they do.

    The food supply chain had for decades been increasingly adapted to meeting the needs of two very different methods of distributing food products; X amount of capacity was dedicated to the at-home grocery model, while Y had been set up for the growing penchant for eating out (among the increasingly fewer able to afford it). Essentially, two separate supply chains which don’t easily mix; if at all.

    Not only that, food distributors can’t simply switch from one to the other. And even if they could, the costs of doing so, and the anticipated payback when undertaking this, were and are massive considerations. McKinsey calculated these trade-offs in the middle of last year, sobering hurdles for an already stretched situation back then:

    Moreover, many food-service producers have already invested in equipment and facilities to produce and package food in large multi-serving formats for complex prepared-, processed-, frozen-, canned-, and packaged-food value chains. It would be highly inefficient to reconfigure those investments to single service sizes.

    And if anyone had reconfigured or would because they felt this economic shift might be more permanent:

    For food-service producers, the dilemma is around the two- to five-year payback period of new packaging lines. Reinvesting and rebalancing a food-service network for retail is not a straightforward decision. Companies making new investments would be facing a 40 percent or more decline in revenue. And any number of issues could extend the payback period or make investments unrecoverable. Forecasts are uncertain, for example, about the duration of pandemic-related demand shifts, the recovery of the food-service economy, and the timeline of returning to full employment.

    So, for some the accordion of shuttered restaurants squeezed food distributors far more toward the grocery and take-home way of doing their food businesses. And it may have seemed like a great bet, or less disastrous, as “two weeks to slow the spread” morphed to other always-shifting government mandates which appeared to make these non-economics of the pandemic a permanent impress.

    More grocery, less dining. Forever after.

    In one famous example, Heinz Ketchup responded to what some called the Great Ketchup/Catsup? Shortage by rearranging eight, yes, eight production lines to spit out their tomato paste in individual servings rather than bottles. CEO Miguel Patricio told Time Magazine back in June (2021) there hadn’t actually been any shortage of product, just the wrong packaging for it:

    It’s not that we don’t have ketchup. We have ketchup, but in different packages. The strain on demand started when people stopped going to restaurants and they were ordering takeout and home delivery. There would be a lot of packets in the takeout orders. So we have bottles; we don’t have enough pouches. There were pouches being sold on eBay.

    But then…vaccines. Suddenly, after over a year of the above, by April 2021 the doors were flung back open, stir-crazy Americans flew back to their local pubs and establishments (see: below) and within months, according to retail sales, it was almost back to normal again. Meaning pre-COVID.



    The accordion had expanded back out but how much of the food services supply chain had been converted to serve the eat-at-home way which many companies had understandably been led to believe was going to be a lasting transformation?

    Do they undertake even more costly and wasted investments to go back? Maybe they resist, just shipping what they have even if not fully suited in the way it had been before all this began.

    Does Heinz spend the money to reconfigure those same eight production lines so as to revert to producing their ketchup in bottles? Almost certainly, but equally certain they’re going to take their sweet time doing it; milking every last ounce of efficiency – limiting their losses, really – they can out of what may prove to have been a bad decision (again, you can’t really fault Mr. Patricio for being unable to predict pandemic politics).

    Rancher Greg Newhall of Windy N Ranch in Washington likewise told NPR that he has the animals, beef, pork, lamb, chicken, goat, but distributors are caught in the accordion (Newhall didn’t use that term):

    NEWHALL: People don’t understand how unstable and insecure the supply chain is. That isn’t to say that people are going to starve, but they may be eating alternate meats or peanut butter rather than ground beef.

    GARCIA-NAVARRO: Newhall says he hasn’t had any issues raising his animals. It’s the processing and shipping that’s the bottleneck, as the industry’s biggest players pay top dollar to secure their own supply chains.

    The usual credentialed Economist NPR asked for comment first tried to blame LABOR SHORTAGE!!! issues, including those the mainstream had associated with the pandemic (closed schools forcing parents to stay home, or workers somehow deathly afraid of working in close proximity with others) before then admitting:

    CHRIS BARRETT: And there’s also the readjustment of the manufacturing process. As restaurants are quickly opening back up, the food manufacturers and processors have to retool to begin to supply again the bulk-packaged products that are being used by institutional food service providers.

    With US retail sales continuing at an elevated rate, the pressures on the goods sector are going to remain intense.


    Because, however, this is not inflation – there’s no monetary reasons behind the price gouge – the economy given enough time will adjust. And it has adjusted in some ways, very painful ways.

    Painful in the sense beyond just hyped-up food prices and what we pay for gasoline lately, the services sector has instead born the brunt of this ongoing adjustment. Consumers have bought up goods (in retail sales) at the expense of what they aren’t buying in services (not in retail sales); better pricing for sparsely available goods stuck in supply chains, seeming never-ending recession for service providers.

    According to the BEA’s last figures, overall services spending remains substantially lower than when the recession began last year. And it shows in services prices which had been temporarily boosted by Uncle Sam’s helicopter only to quickly, far more speedily and noticeably fall back in line with the prior, pre-existing disinflationary trend following a much smaller second camel hump.



    Once the supply and other non-economic issues get sorted out, we would expect the same thing in goods, too. It is already shaping up this way, though bottlenecks and inefficiencies are sure to remain impediments and drags well into next year.

    Those include other factors beyond food or domestic logistical nightmares. Port problems, foreign sourcing, etc. The accordion has played the entire global economy, and in one sense it has created the illusion of recovery and inflation out of a situation which in reality is nothing like either.

    That’s the literal downside of transitory. We can see what the price bulge(s) had really been, and therefore what it never was.

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