The Fed Is Setting The Stage For Hyper-Inflation Of The Dollar (#GotBitcoin?)
Policy makers have begun talking about letting the inflation rate rise above its 2% target. Look for a formal statement soon. The Fed Is Setting The Stage For Hyper-Inflation Of The Dollar (#GotBitcoin?)
The Fed’s traditional Phillips curve approach to forecasting inflation, which relies on the theory that inflation accelerates as unemployment falls, was widely criticized during the most recent economic recovery. Inflation remained quiescent in the wake of the Great Financial Crisis even as the unemployment rate fell to 3.5%, well below the 2012 high estimate of the natural rate, or 5.6%. The Fed’s commitment to Phillips curve-based inflation forecasts induced it to raise interest rates too early in the cycle and continue to boost rates into late 2018 even as faltering markets signaled the hikes had gone too far. The Fed was eventually forced to lower rates 75 basis points in 2019 to put a floor under the economy. Inflation remained stubbornly below the Fed’s 2% target throughout that period.
Faced now with the prospect of another prolonged period of low inflation, Fed officials are signaling they will place less emphasis on Phillips curve estimates when setting policy. Fed Governor Lael Brainard said this week that “with inflation exhibiting low sensitivity to labor market tightness, policy should not preemptively withdraw support based on a historically steeper Phillips curve that is not currently in evidence.”
No longer are estimates of longer-run unemployment taken as almost certainly indicating the economy is at full employment. Instead, Brainard said the Fed should focus on achieving “employment outcomes with the kind of breadth and depth that were only achieved late in the previous recovery.” The Fed is going to try to run the economy hot to push down unemployment.
By de-emphasizing the Philips curve, the Fed loses its primary inflation forecasting tool. Instead of an inflation forecast, the Fed will rely on actual inflation outcomes to determine the appropriate time to change policy. Brainard pointed out that “research suggests that refraining from liftoff until inflation reaches 2% could lead to some modest temporary overshooting, which would help offset the previous underperformance.”
Think about what she is saying. Traditionally, the Fed attempts to reach the inflation target from below, effectively using the unemployment rate to forecast inflation and then moderating growth such that projected inflation doesn’t exceed its target. Brainard is saying the Fed should not tighten policy until actual inflation reaches 2%. Policy lags — the time between the Fed’s actions and the resulting economic outcomes — mean inflation will subsequently rise above 2%. The Fed would thus overshoot the inflation target and then return to the target from above.
Federal Reserve Bank of Philadelphia President Patrick Harker goes even further in a Wall Street Journal interview, saying “I don’t see any need to act any time soon until we see substantial movement in inflation to our 2% target and ideally overshooting a bit.” Expect to see more Fed speakers also saying they want inflation at or above 2% before they tighten policy. Also expect to see something along these lines codified at in a policy statement.
This shift also has implications for the Fed’s ongoing review of policy, strategy, and communications. When Brainard talks about offsetting “previous underperformance,” she is giving a green light to a “make-up” strategy in which the Fed compensates for a period of below-target inflation with a period of above-target inflation. The Fed’s current policy does not allow for such a strategy. The broad willingness to accept overshooting implies that the Fed’s policy review will conclude with a shift toward some form of average inflation targeting in which the central bank explicitly sets policy to compensate for errors such that inflation averages 2% over time.
The implication for financial markets is that the Fed expects to hold policy very easy for a very long time. They will reinforce this stance with enhanced-forward guidance and, eventually, yield-curve control. As long as inflation remains below 2%, the Fed will push back on any ideas that they will tighten policy anytime soon. And even inflation above 2% wouldn’t guarantee tighter policy if the Fed concluded the overshoot was transitory. Don’t doubt the Fed’s resolve to keep policy accommodative. They will keep reminding you if you forget.
Fed’s Harker Backs Allowing Economy To Run Hot Before Raising Interest Rates
Philadelphia Fed president backs no interest rate hike until inflation moves above 2% annual inflation target.
Philadelphia Fed President Patrick Harker on Wednesday said he would support a change in monetary policy where the central bank would let the economy run hot until inflation rises above the central bank’s 2% annual target before raising borrowing costs.
“I’m supportive of the idea of letting inflation get above 2% before we take any action with respect to the federal funds rate,” Harker said, in an interview on Bloomberg Television.
Harker is a voting member of the Fed’s interest rate committee this year.
On Tuesday, Fed Governor Lael Brainard also backed the idea of letting inflation get over 2% before the Fed takes any action to raise interest rates. This promise is called “foward guidance” at the central bank. Typically, the Fed would hike rates preemptively if it saw inflation surging.
Former Fed staffer, and now Fed watcher, Krishna Guha said he saw support rising for this new policy and strengthened forward guidance and said it was good for investors who want to take risks.
“Harker’s comments suggest growing momentum behind this view at the U.S. central bank and should continue to support risk-appetite as investors look ahead to the coming Fed pivot to a new phase of monetary policy in which the FOMC will make longer range commitments on both rates and quantitative easing,” Guha, now the vice chairman of Evercore ISI, said in a note to his clients.
Harker said that controlling COVID-19 was critical to restoring the health of the economy. He said he was “a little skeptical” that the July employment report would be as strong as the prior two month’s reports given the resurgence of the virus in the South and West.
Harker said he was revising down his forecast for economic growth as a result of the spread of the coronavirus.
In a webcast speech later Wednesday to the Center City Proprietors Association, Harker said he expected a negative 20% growth rate in the first half of the year, followed by a 13% gain in the second half. The result would be minus 6% for the entire year.
“That’s a much sharper recession than we experienced during the financial crisis,” he said.
“This is going to be a slow recovery. Until we get the virus under control, we can’t get the economy back to full throttle,” he said.
What’s Behind The Fed’s New Push To Promote Inflation?
Why the Fed’s strategy on inflation is changing and why the definition used by America’s central bank may be hurting regular people.
Fed To Allow For Periods Where Inflation Runs Above The Central Bank’s 2% Target
Central bankers look to change long-running strategy to encourage lower rates, shift unemployment-inflation dynamic.
The Federal Reserve is preparing to effectively abandon its strategy of pre-emptively lifting interest rates to head off higher inflation, a practice it has followed for more than three decades.
Instead, Fed officials would take a more relaxed view by allowing for periods in which inflation would run slightly above the central bank’s 2% target, to make up for past episodes in which inflation ran below the target.
“It would be a significant change in terms of how they are thinking about” the trade-off between employment and inflation, said Jan Hatzius of Goldman Sachs. “A lot of those things look very different now from the way they looked a few years ago,” he said.
Fed Chairman Jerome Powell hinted at the shift at a news conference last week when he said the central bank would soon conclude a comprehensive review of its policy-making strategy that began last year.
Mr. Powell initiated the review with an eye toward beefing up the Fed’s ability to counteract downturns in a world where interest rates are lower and more likely to remain pinned at zero.
Even before the severe shock from the coronavirus pandemic, the Fed had grown concerned about spells of low inflation that have bedeviled authorities in Japan over the past two decades and in Europe for the past decade.
The change being contemplated now is a way of essentially telling markets that rates will stay low for a very long time. Markets have likely already picked up on this change, given the continued declines in long-term interest rates.
The changes on their own will do little to provide more support to the economy right now because investors already understand that the Fed isn’t likely to raise interest rates for years, said Steven Blitz, chief U.S. economist at research firm TS Lombard. “It is a change at this point without meaning. It’s just words,” he said.
The Fed would formally adopt changes by altering a statement of long-run goals that it approves annually, something it last did in January 2019. “The changes we’ll make…are really codifying the way we’re already acting with our policies,” Mr. Powell said last week.
One way for the Fed to do that would be to amend that document to say inflation should average 2% “over time.”
The virus shock led the Fed in March to rapidly slash short-term rates to zero, purchase trillions of dollars in government-backed debt and deploy an array of programs to backstop lending markets.
Because of the pandemic, Mr. Powell tabled discussions this spring over the framework review. The Fed resumed those discussions at their two-day meeting last week and could seek to conclude them as soon as their Sept. 15-16 meeting.
The Fed formally adopted the 2% inflation goal, a level it regards as consistent with healthy economic growth, in 2012. At the time, short-term rates also were pinned near zero. But central bankers, economists and investors still expected those rates to return to more normal levels of 4% or so once the economic expansion matured.
Even before the pandemic hit, those rates were stuck at much lower levels than 4% for reasons that weren’t expected to change soon, such as demographics, globalization, technology and other forces that have held down inflation.
The Fed justified pre-emptive rate increases because monetary policy works with a lag. “Now, you’re saying, ‘Yes, there may be lags behind, but we’re OK with an inflation overshoot because inflation has run so much below,’” said Priya Misra, an interest-rate strategist at TD Securities.
The Fed says its current 2% inflation target is symmetric, meaning officials are as uncomfortable with inflation somewhat below as somewhat above that level. In other words, 2% isn’t a ceiling. In addition, the Fed under this approach is always aiming for 2%, and it doesn’t take into account previous deviations.
The problem for some officials is that the results haven’t been symmetric; inflation has run at or under the target, but never above it.
The Fed’s misses on inflation over the past five years were relatively small. But some officials were concerned because if the Fed can’t meet its target after a long time, consumers and businesses could expect even lower inflation. Such expectations can become self-fulfilling, and officials would be alarmed if they were falling because of the important role expectations play in determining actual prices
In speeches over the past year, Fed governor Lael Brainard has called for shedding the current approach and taking up a way to make up for past misses of the target.
Last month, Ms. Brainard approvingly cited research that would have the Fed refrain from raising rates until inflation reached 2%, rather than initiating rate increases before achieving the target and on the basis of a forecast of higher inflation, as the Fed did in 2015.
Any changes the Fed makes would coincide with a deeper emphasis on the benefits of very low levels of unemployment. For years, officials were concerned that allowing unemployment to fall too low could generate undesirable levels of inflation, which occurred after the 1960s.
In the most recent expansion, however, officials were surprised to find unemployment falling to levels associated with higher prices, but without the anticipated inflation.
By raising rates based on a forecast of higher inflation, the Fed risks short-circuiting a labor-market expansion when many of the most disadvantaged workers are finally getting jobs or raises. That can be costly if inflation doesn’t materialize, said Atlanta Fed President Raphael Bostic on Twitter last month.
“This isn’t inflation for inflation’s sake,” said Mr. Bostic.
The changes under consideration “would be very meaningful because it would be memorializing their commitment to working toward a tighter labor market when the economic circumstances allow for it,” said Rep. Denny Heck (D., Wash.), who is on the House Financial Services Committee. “It would be a huge break from the past.”
BlockTower’s CIO Predicts Hyperinflation Could Send Bitcoin Parabolic
Ari Paul, CIO at BlockTower Capital crypto hedge fund, believes Bitcoin’s next parabolic move will soon be triggered by hyperinflation caused by central banks’ monetary policies.
Ari Paul, CIO and co-founder at crypto hedge fund BlockTower Capital, believes Bitcoin’s next parabolic move will soon be triggered by hyperinflation caused by the monetary policies of central banks.
According to Paul, the Federal Reserve will eventually need to devalue the dollar as a means to pay its increasingly high sovereign debt.
In that scenario, according to Paul, we’ll enter a period of hyperinflation similar to the Great Inflation in the 1970s. During such an event, investors could move their wealth away from dollars and Treasury bonds and into inflation-resistance assets.
“If we have a return to something like the 1970s, I think probably gold rallies five to 10X or more, I think Bitcoin probably rallies 10 to 30X or more”, he claimed.
Paul believes this process has already started and that we are already in an “inflationary market, a Bitcoin bull market and gold bull market in the early stages”.
He also said “Bitcoin is like a call on inflation,” meaning that as long as the expectation of high inflation remains high, the price of the call (Bitcoin) will also increase.
Global Recession Supercharges Federal Reserve As Backup Lender To The World
When the coronavirus halted the global economy, the U.S. central bank lent massively to foreign counterparts.
When the coronavirus brought the world economy to a halt in March, it fell to the U.S. Federal Reserve to keep the wheels of finance turning for businesses across America.
And when funds stopped flowing to many banks and companies outside America’s borders—from Japanese lenders making bets on U.S. corporate debt to Singapore traders needing U.S. dollars to pay for imports—the U.S. central bank stepped in again.
The Fed has long resisted becoming the world’s backup lender. But it shed reservations after the pandemic went global. During two critical mid-March weeks, it bought a record $450 billion in Treasurys from investors desperate to raise dollars. By April, the Fed had lent another nearly half a trillion dollars to counterparts overseas, representing most of the emergency lending it had extended to fight the coronavirus at the time.
The massive commitment was among the Fed’s most significant—and least noticed—expansions of power yet. It eased a global dollar shortage, helped halt a deep market selloff and continues to support global markets today. It established the Fed as global guarantor of dollar funding, cementing the U.S. currency’s role as the global financial system’s underpinning.
Just as the Fed expanded its role in the U.S. economy to an unprecedented degree during the 2008 financial maelstrom, it has in the coronavirus crisis expanded its power and influence globally.
“The Fed has vigorously embraced its role as a global lender of last resort in this episode,” said Nathan Sheets, a former Fed economist who was the Treasury Department’s top international deputy from 2014 to 2017 and now is chief economist at investment-advisory firm PGIM Fixed Income. “When the chips were down, U.S. authorities acted.”
The value of the dollar has tumbled in recent weeks against other currencies as investors grow more troubled about the economic outlook and difficulty containing the coronavirus. Still, it is trading near levels recorded before the pandemic hit this year and above its long-term average on a trade-weighted basis, said Mark Sobel, a former U.S. Treasury Department official now at the Official Monetary and Financial Institutions Forum, a London-based think tank.
Concerns that short-term declines in the dollar are an omen that its standing as the global reserve currency faces a threat are “vastly overdone,” he said.
The Fed supplied most of the money abroad via “U.S. dollar liquidity swap lines.” In essence, it lends dollars for fixed periods to foreign central banks and in return takes in their local currencies at market exchange rates. At the loans’ end, the Fed swaps back the currencies at the original exchange rate and collects interest.
By stabilizing foreign dollar markets, the Fed’s actions likely avoided even greater disruptions to foreign economies and to global markets. Those disruptions could spill back to the U.S. economy, pushing the value of the dollar higher against other currencies and damping U.S. exports—and the economy.
The risks to the Fed are minimal given that it is dealing with the most creditworthy nations and the most advanced central banks. But there are risks that investors come to expect a safety net for dollars that might lead to riskier borrowing during good times.
The Fed began deploying the swap facilities on March 15. By the end of March, it had expanded them to include 14 central banks while launching a separate program for those without swap lines to borrow dollars against their holdings of Treasurys. By May’s end, the total lent out under the programs peaked at $449 billion.
The Fed’s goal is to keep financial markets functioning, and the March events had the makings of a global panic with a resulting rush for cash. The aim was to prevent investors from dumping Treasurys and other dollar-denominated assets such as U.S. stocks and corporate securities to raise cash, which would have driven prices of those assets even lower.
Fed Chairman Jerome Powell in a May 13 webcast acknowledged the Fed’s global role more explicitly than his predecessors had during the last global financial crisis. The loans let foreign central banks supply dollars cheaply to their banking systems and stopped everyone in that chain from panic-selling assets like U.S. Treasurys to raise cash, he said: “It had a very constructive effect on calming down those markets and reducing the safety premium for owning U.S. dollars.”
Andrew Hauser, the Bank of England’s top markets official, in an early June speech said those swap lines “may be the most important part of the international financial stability safety net that few have ever heard of.”
On July 29, the Fed said it would extend the temporary programs, originally scheduled to end in September, through March 2021. “The crisis and the economic fallout from the pandemic are far from over,” Mr. Powell said, “and we’ll leave them in place until we’re confident that they’re no longer needed.”
The shift has brought little of the scrutiny the Fed saw during the 2008-2009 crisis. When Mr. Powell appeared before Congress for hearings in June, lawmakers didn’t ask a single question about the huge sums the central bank made available to borrowers abroad.
The Fed’s governing charter from Congress gives it the authority to operate the swap lines, which it has done in some form since 1962, when the Fed heavily debated whether it had the authority to conduct foreign-exchange operations. Congress could revoke these authorities if it didn’t approve of how the Fed was using them.
The swaps are structured so that the Fed’s foreign counterparts bear the risk of loans going bad or currency markets moving the wrong way. A large portion of the Fed’s overseas loans have recently been swapped back as markets around the world have recovered.
The Fed’s aggressive overseas lending has injected it into the world of foreign policy: Not every country gets equal access to the Fed’s dollars. Turkey, for example, has appealed unsuccessfully for dollar loans from the Fed to support its sinking currency, according to public comments made in April by the U.S. ambassador to Turkey, David Satterfield. A representative for the Turkish central bank didn’t respond to a request for comment.
Those decisions are based on creditworthiness, but political considerations could pose a threat to the Fed’s independence, said Mr. Sheets, the former Fed economist. When the Fed rolled out the lending program during the 2008 financial crisis, central-bank officials consulted with the leadership of the Treasury and State Department to make sure any operations were consistent with broader U.S. objectives, he said.
“The Fed was keenly aware of this tension that, yes, this was monetary policy, but it was abutting some broader issues that were not typically the Fed’s area,” said Mr. Sheets. Concerns that such lending programs could suck the Fed into broader foreign policy entanglements were a “meaningful constraint” on the expansion of the swap lines, he said.
The moves have also left the world ever more tied to a single country’s economic management and central bank. Efforts have persisted for years to dilute the dollar’s central role, via the euro, then the Chinese yuan. But knowing the Fed is willing to step in has led banks, businesses and investors to flock to the U.S. currency.
This gives the U.S. enormous power—to punish foreign banks for violations of U.S. sanctions, for instance, or to consider options like breaking the Hong Kong dollar’s peg to the dollar, something U.S. officials considered earlier in July, The Wall Street Journal reported, to punish China for its treatment of the city, before shelving the idea.
It also has produced a familiar cycle, said Stephen Jen, chief executive of Eurizon SLJ Capital Ltd. in London and a longtime currency analyst and money manager.
Investors value the dollar for its safety. But every time there is a major market stress there is a run to the currency, leading to breakdowns in the market, which forces the Fed to step in, which reinforces investors’ faith in the dollar, he said. “People have become more dependent on the dollar than any other currency,” he added.
The Fed pioneered the current version of central-bank swap lines in 2007, when rising U.S. subprime-mortgage delinquencies jolted short-term debt markets and made it hard for big European banks to borrow dollars. Initially, the Fed lent to some European banks’ U.S. subsidiaries. It later rolled out swap lines to two foreign central banks, allowing the Fed to lend dollars with less risk, and expanded them to a dozen others over 2008 and 2009.
The Fed activated some of the swaps again in 2010 and 2011, as Eurozone debt problems mounted, and set up standing facilities with five major central banks in 2013. One Fed bank president formally objected, saying that the swaps effectively let European banks borrow at lower rates than U.S. banks and that they were an inappropriate incursion into fiscal policy.
When coronavirus shutdowns hit the U.S. and Europe in March, oil prices plunged and stocks plummeted. Companies drew down bank credit lines, socking away dollars to pay workers and bills as revenue vanished. Financial markets showed alarming signs of dollar demand.
March 16, among the worst days in recent market history, brought the financial system to the brink. Stock prices plunged globally as investors scrambled to raise cash. Banks sharply increased the cost of lending dollars to each other. Foreign banks were forced to pay dearly, gumming up the flow of dollars to their customers.
In South Korea, big brokerages suddenly found themselves in need of large sums of dollars to meet margin calls, according to Tae Jong Ok, a Moody’s Investors Service analyst who covers financial institutions in the country.
They had previously borrowed money to buy billions of dollars of derivatives tied to stocks in the U.S., Europe and Hong Kong. When those stocks plunged, lenders demanded they put up more cash. The scramble for dollars helped push the Korean won to its lowest level in a decade on March 19.
Japanese banks suffered, too. Many had made loans directly to U.S. borrowers. The sector also owned more than $100 billion of collateralized loan obligations—bonds backed by bundles of loans to low-rated U.S. companies—that in some cases had been bought on short-term credit and needed to be regularly refinanced.
Insurers in Japan that had invested heavily in higher-yielding assets abroad also had difficulty securing dollars to fund their trades.
In Singapore, high borrowing costs affected the dollar supply to companies needing to pay off debt or import and export goods, according to bankers in the city-state. “There was a classic ‘dash for cash’ scenario,” said a representative of the Monetary Authority of Singapore, adding that dollar-market conditions became so strained there was indiscriminate asset-selling.
Central bankers from Singapore, South Korea, Australia and elsewhere swapped tales of the carnage on a regular call that included a representative of the Fed, according to people familiar with the calls.
As the crisis snowballed, the Fed increased purchases of Treasurys from $40 billion a day on March 16 to a record $75 billion days later. It also expanded the dollar swap lines to nine other countries. By March 31, the Fed had launched a new program that let some 170 central banks borrow dollars against their holdings of U.S. Treasurys.
The rollout was faster and broader than when the Fed tentatively introduced the swap lines during the financial crisis a decade earlier. Back then, “it was improvisation,” said Adam Tooze, a Columbia University history professor who writes about financial crises and war. “Today, it seems extremely deliberate.”
As financial markets recovered, dollar borrowing costs for many banks and companies outside the U.S. fell. The Fed’s outstanding currency swaps started receding in mid-June, as a wave of transactions matured and weren’t renewed, and fell further to $107.2 billion as of July 30.
The facility that lets central banks borrow against Treasury holdings hasn’t seen much use. Analysts said its presence alone helped stop the scramble for dollars.
While the Fed’s actions during the financial crisis sparked outrage—seen to be aiding firms that caused the crisis—there have been no concerns raised publicly by U.S. lawmakers or Fed officials about the Fed’s growing global role. “The whole pandemic is a different enemy,” said William Dudley, New York Fed president from 2009 to 2018. “The political support for the Fed to be aggressive is much broader this time.”
The Fed has had little choice but to intervene, given the dollar’s global centrality. Some 88% of the $6.6 trillion in currency trades that take place on average daily involve dollars, according to the Bank for International Settlements, or BIS. The dollar is also the most commonly used currency in cross-border-trade in commodities and other goods.
In addition, low American bond yields over the past decade prompted many big investors to send dollars to emerging markets. By the end of 2019, the volume of U.S. dollar-denominated international debt securities and cross-border loans reached $22.6 trillion, up from $16.5 trillion a decade earlier, according to BIS data.
Discontent about the dollar’s growing dominance has percolated for years, including among U.S. allies. Mark Carney, the Bank of England’s governor at the time, took aim at the dollar’s “destabilizing” role last August in a keynote speech at an annual central-bankers gathering in Jackson Hole, Wyo.
He argued the dollar’s growing role in international trade was out of step with America’s declining share of global output and exposed developing countries to damage from changes in U.S. economic conditions. He also outlined a proposal for central banks to create their own reserve currency.
The Trump administration’s use of tariffs and sanctions has spurred more countries to seek trading arrangements that bypass the dollar, but the efforts have had little effect.
One irony of the U.S. financial crisis was that the dollar’s use overseas only increased in its aftermath. One reason was the Fed: Its liberal lending during the crisis convinced investors that whatever happened, their access to dollars was more or less assured.
A decade ago, Jonathan Kirshner, a Boston College political science and international studies professor, predicted a decline in the dollar’s international role.
Its performance has been more robust than he anticipated, he said in a recent interview: “In the absence of viable alternatives, the dollar endures as the most important currency for the world.”
Why Cryptocurrency Is More Than A Hedge Against US Dollar Inflation
Precious metals used to be the best way to protect your portfolio from natural value deterioration, but Bitcoin is changing the game.
During times of international economic crisis, governments print money. This leads to inflation and investors subsequently stashing their investment capital in long-term, stable investments. Historically, that has meant gold, but in the current economic crisis, gold has been joined by another long-term store of value: Bitcoin (BTC).
There are several good reasons for this. The United States Federal Reserve is handling the crisis terribly, and has responded to soaring unemployment numbers in the same way they always do: by printing money. Already, the dollar has lost 5% of its value, with predictions that this is only the beginning. The currency is expected to shed up to 20% in the next few years, according to analysts at Goldman.
Alongside this devaluation has come another threat to investors: deflation. With the value of dollar assets dropping rapidly and the worst yet to come, investors are looking to Bitcoin as a hedge against deflation. This appears to be the primary reason why Bitcoin has retained its value despite woeful news in other parts of the economy.
Are these investors correct, though? Can cryptocurrency act as a hedge against the dollar’s inflation? Let’s dive into it.
Inflation And Deflation
For crypto investors accustomed to dealing with daily — or even hourly — market movements, it can sometimes be easy to forget about the macro-level trends that drive our economy. Inflation is one of these, and it’s useful to have a broad definition of the term before we look specifically at the role of crypto in beating it.
Essentially (and as you might remember from Economics 101), inflation generally comes about because of a general decrease in the purchasing power of fiat money. Many things can cause this loss of purchasing power: foreign investors pouring out of a particular currency, or even investors attacking a currency.
Most often, though, inflation is the result of an increase in money supply, like when the Fed unilaterally creates billions of dollars and sends out checks to millions of Americans, for instance.
Deflation is the opposite. In deflationary scenarios, prices decrease as fiat currency increases in value relative to different goods and services. Again, there can be different causes for this, but it generally comes about due to tightly controlled fiscal policies, or technological innovation.
The Global Pandemic And Inflation
The key point in these definitions is that inflation can only occur in fiat currencies — i.e., those not based on the market value of a tangible asset, but largely on confidence in growing gross domestic product. Since the Bretton Woods agreement of 1944, the latter has been the basis of the U.S. dollar’s value.
Having a fiat currency gives governments a powerful degree of freedom when it comes to printing money, and supposedly when it comes to controlling inflation. However, when confidence in the government is low (as it is now), government spending programs can lead to inflation quickly getting out of control. In the 1970s, gold boomed because investors saw it as a hedge against the dollar’s rapid inflation.
This is similar to what is happening now. The global COVID-19 pandemic has given rise to a massively inflationary monetary policy and aggressive expansion of money supply while prices in certain key areas such as food staples keep increasing due to supply shocks caused by lockdowns.
In this environment, it’s no surprise that gold is booming. There is, after all, only a limited supply of gold on earth, and so its price cannot easily be affected by government policy. Some crypto currencies, however, are also booming — apparently for the same reason. Billionaire investors are therefore lining up to compare Bitcoin to gold.
Bitcoin: A Deflationary Asset?
The reason why some forms of cryptocurrency can act as a hedge against inflation is precisely the same reason gold can: there is a limited supply. This is something that is often forgotten about by many, even those in the crypto space, but it’s worth remembering that many cryptocurrencies — and most notably, Bitcoin — are built with an inherent limit.
The 21 million Bitcoin limit means that at a certain point, there should be fewer Bitcoins versus the demand for them, meaning that in terms of value, the price per unit should increase as the supply decreases.
In addition, the fact that Bitcoin allows investors to limit their exposure to government surveillance networks means that, in this time of low confidence in government, many people are moving their investments away from the U.S. dollar and toward crypto in order to avoid inflation and government tomfoolery. In other words, the comparison with gold investments of previous crises seems pretty apt.
But here’s the thing: It’s not completely clear that Bitcoin is, in fact, a deflationary asset. Or at least, not yet. While it is technically true that the supply of the currency is limited, we are nowhere near that limit, with most estimates putting the last Bitcoin to be mined in 2140. What this means, in practice, is that Bitcoin will be unable to act as a completely stable hedge against inflation for at least another 120 years.
Flexibility And Stability
This might not matter that much, of course. One of the primary driving forces behind the rise of Bitcoin has been the combination of (relative) stability and (relative) variability that it affords. In this context, it’s heartening that investors now regard crypto as a stable hedge against an inflating U.S. dollar, but to regard crypto as merely a replacement for gold would be to miss the point: Cryptocurrency is far more than just a hedge.
It’s Time To Build Cash To Take Advantage of Stocks’ Coming Tumble
Summertime, and the livin’ is uneasy. Stocks are jumpin’ and the market is high. So, hush, all you skeptics, don’t you whine.
With apologies to the Gershwins and DuBose Heyward, this mangling of the lyrics of “Summertime” from Porgy and Bess seems appropriate, as the stock market’s benchmark, the S&P 500 index, is on the verge of reclaiming its record peak in this summer of our disquiet, if not discontent.
Stock market highs are associated with upbeat songs, such as Irving Berlin’s “Blue Skies,” to cite another tune from that bygone era. “Never saw the sun shining so bright, never saw things going so right,” went this popular 1929 ditty.
With the S&P 500 ending the week a fraction of a percent below its Feb. 19 high close of 3386.17, the disparity between the equity market and the real economy, which is struggling to cope with the coronavirus pandemic, remains stark.
As a measure of how far we’ve come, Thursday marked the 100th day since the S&P 500’s low of March 23, writes Ryan Detrick, chief market strategist of LPL Financial, in a research note. The 50%-plus rebound since then marks the best 100-day gain for the big-cap benchmark, “while millions of people have lost their jobs and tragically more than 160,000 Americans have lost their lives,” he adds.
In the past, large 100-day rallies usually were followed by continued gains, with stocks higher a year later in 17 out of 18 instances, Detrick adds. But other market observers see more risk than reward as the S&P 500 approaches its previous highs.
Sentiment is nothing if not frothy. That’s evident in the “very vigorous public participation” in the market, remarks Julian Emanuel, chief equity and derivatives strategist for BTIG. More than the massive rise in the “FAAGM” megacap tech names, froth was evident in the bidding up of recent stock splits, which made even less sense than the rush into bankruptcy stocks. (For more on splits, read this.)
Given the availability of fractional shares on many online brokers’ platforms, the positive impact of splits on high-profile stocks, such as Apple (ticker: AAPL) and Tesla (TSLA), is further evidence of irrational exuberance that recalls the frenzy of the dot-com bubble at the turn of the 21st century.
More important, the disconnect between the stock market and underlying fundamentals is unequivocally the greatest in the past 30 years, Emanuel says in a telephone interview. There are other disconnects, too. A seemingly small example: To a football fan, it didn’t seem coincidental that the market rolled over when the Big Ten said that it would cancel the fall season, he notes.
Indeed, the S&P 500’s valuation at 26 times expected earnings, at the same time that the economy confronts the clear and present danger of a relapse, makes for a significant headwind to the stock market, Emanuel continues.
That’s even before considering the political season ahead, in which the invective will only get nastier, and continued wrangling over much-needed relief for households will persist. Then there’s the inexplicable but persistent tendency of the stock market to get battered in September, in the middle of the Northern Hemisphere’s hurricane season.
The key question for investors to ask themselves is how they would react in the event of a typical 10% to 15% correction, Emanuel says. Such a setback should be far from surprising, given the current state of the market and the underlying fundamentals. But it wouldn’t be the start of a new bear market, he emphasizes.
If you aren’t prepared to put more money to work in the market during such a drawdown, you own too many stocks now, he pointedly advises. He suggests taking some chips off the table to raise cash, and rotating out of the huge winners into laggard sectors, such as energy and financials, as well as health-care stocks.
What seems apparent is that investors have embraced the view of Dr. Pangloss, who famously asserted in Voltaire’s Candide that this is the best of all possible worlds, writes James Montier of GMO, the institutional money manager, in a client note.
Voltaire also wrote, “Doubt is not a pleasant condition, but certainty is absurd,” an observation that Montier says applies to the U.S. stock market.
Suddenly, It’s Not Just Bitcoiners Who Think the Dollar’s Going Down
As the news broke in recent days that Warren Buffett’s Berkshire Hathaway had bought shares in a gold miner, commentators immediately began to wonder if the billionaire investor might be betting against the U.S. economy or the dollar.
Bitcoin analysts and investors wondered why it took him so long, given the trillions of dollars of money pumped into the financial system this year by the Federal Reserve to help fund the ballooning U.S. national debt.
“The money printer working overtime is obviously causing Buffett and his board grave concern,” Mati Greenspan, of the foreign-exchange and cryptocurrency research firm Quantum Economics, wrote Monday. “While Buffett is perhaps not so sure how to react to a world that no longer values bonds and government debt, others are sure.”
There’s a growing sense among members of the cryptocurrency community that their longstanding assessment of the traditional financial system as unsustainable is finally gaining traction among Wall Street experts and mainstream investors. If the concerns spread, it might buoy prices for bitcoin, which many digital-asset investors view as an inflation hedge similar to gold.
Goldman Sachs, which in May of this year panned bitcoin as “not a suitable investment,” hired a new head of digital assets earlier this month and acknowledged rising interest in cryptocurrencies from institutional clients. The firm warned in July that the U.S. dollar was at risk of losing its status as the world’s reserve currency.
Dick Bove, a five-decade Wall Street analyst who now works for the brokerage firm Odeon, wrote last week in a report that the U.S. dollar-ruled financial system could come to an end amid challenges from a possible multi-currency system, which include digital currencies.
“The case for bitcoin as an inflationary hedge and sound investment is being articulated with crystal clarity by influential people outside of our crypto bubble,” the digital-asset analysis firm Messari wrote last week. Buffett didn’t return a call for comment.
Dollar Dominance On The Wane?
Whether or not bitcoin and other cryptocurrencies are the answer, there’s little on the horizon that might turn investors away from the gnawing sense that U.S. finances are becoming more precarious.
Goldman Sachs economists predicted in an Aug. 14 report that the Federal Reserve will pump $800 billion more into financial markets by the end of this year, followed by another $1.3 trillion in 2021.
According to Bank of America, there’s a risk investors might shift their “portfolio allocation out of U.S. dollar assets” to position for the “erosion of the hegemony of the dollar as a reserve currency.”
“A constitutional crisis is one dynamic that could potentially accelerate the process of de-dollarization,” they wrote, noting that November’s presidential election might be “fiercely divisive” and “contested.”
According to the bank, a recent survey of fixed-income money managers showed nearly half of respondents expect foreign central banks to decrease their reserve holdings of dollars and dollar-denominated assets over the next year.
It may not sound outlandish to bitcoin bulls.
Fed Chair Powell’s Jackson Hole Speech Could Hint at US Dollar’s Future
A speech by Federal Reserve Chair Jerome Powell scheduled for Thursday offers a reminder of just how dramatically once-slow-moving monetary forces have accelerated due to the devastating economic toll of the coronavirus pandemic.
This time last year, President Donald Trump was vehemently criticizing Powell on Twitter for setting interest rates too high, as U.S. economic growth slowed and the national debt swelled past $22 trillion.
This time last year, then-Bank of England Governor Mark Carney delivered a speech at the Fed’s annual Jackson Hole Economic Symposium in Wyoming warning the U.S. dollar’s status as the de facto global currency contributes to an unsustainable international economic and monetary regime.
He argued that world leaders should create a “synthetic hegemonic currency,” potentially provided “through a network of central bank digital currencies.”
Fast forward to now, and the Jackson Hole conference has been forced to go virtual because of the coronavirus. Trump’s economic stewardship, including a U.S. stock market that many investors now say is propped up by the Fed’s $3 trillion of freshly printed money, has become a core issue in the 2020 presidential election. The national debt now stands at $26.5 trillion.
Digital currencies are now being studied and pursued by central banks in China, the U.S. and just about everywhere else. Goldman Sachs recently warned the dollar risked losing its dominant reserve status.
“The pandemic has sped up key structural trends and triggered substantial market swings,” strategists for the $7 trillion money manager BlackRock wrote this week. “The policy revolution was needed to cushion the devastating and deflationary impact of the virus shock. In the medium term, however, the blurring of monetary and fiscal policy could bring about upside inflation risks.”
As the spread of the coronavirus earlier this year triggered lockdowns and quarantines, the global economy this year entered its deepest recession since the early 20th century.
When markets from stocks to bitcoin swooned in March, the Fed slashed interest rates close to zero and has since announced plans to buy U.S. Treasury bonds in essentially unlimited amounts while providing emergency liquidity for money markets, Wall Street dealers and corporations.
“The road ahead is highly uncertain,” Fed Governor Michelle Bowman said Thursday in a speech in Kansas.
‘No Easy Way Out’ For Powell
Many investors are betting on bitcoin as a hedge against the potential debasement of the U.S. dollar, but Fed officials say deflationary forces might be stronger because of an expected drop off in demand from consumers and households.
Analysts for Bank of America, the second-biggest U.S. bank, wrote earlier this week in a report that bond market traders expect the Fed to adopt a “major new policy framework aimed at better achieving its 2% target” for annual inflation.
As of the last reading, the central bank’s preferred measure of consumer price increases registered just 0.9%, so the baseline expectation is the Fed would let inflation rise well above 2% so that the average over a long period of time gets closer to the target.
“Let us be optimistic and say it takes three years to create some inflation,” Matt Blom, head of sales and trading at the digital-asset firm Diginex, wrote Wednesday in an email. “We would need to drive it above 3.5% and maintain it there for years before we are able to use an average calculation.”
It’s unclear what Fed scenario is already priced into the market, but Bank of America’s Athanasios Vamvakidis, a foreign-exchange analyst, wrote that there is “no easy way out” for Powell and his colleagues.
“Without inflation eventually acting as a budget constraint, we see risks for recurring and worsening bubbles, with further divergence between Wall Street and Main Street,” Vamvakidis wrote.
What Powell’s Speech Could Say About The Dollar’s Future
Crypto traders will focus in the short term on what the Fed’s speech might mean for bitcoin prices, which have surged almost 60% in 2020, far exceeding this year’s 7.7% year-to-date gain in the Standard & Poor’s 500 Index of U.S. stocks.
But the Fed’s actions could also have implications for ether, the native token of the Ethereum blockchain, where entrepreneurs are developing alternative currencies and semi-autonomous lending and trading networks that might one day replace the current financial system. There’s also a fast-growing business in dollar-linked “stablecoins,” with the amount doubling this year to $13 billion.
“So much has changed,” said Joe DiPasquale, CEO of the cryptocurrency-focused hedge fund BitBull Capital. “There is this danger of the U.S. [dollar] in the future no longer being the world’s reserve currency. We are in a much worse position than we were in a year ago.”
Mati Greenspan, founder of the cryptocurrency and foreign-exchange analysis firm Quantum Economics, wrote this week that Powell’s return to Jackson Hole comes at a time when “people are just starting to ask questions about the intrinsic value of money.”
“U.S. authorities have just taken on an inordinate amount of debt, more than they could possibly ever hope to pay back,” Greenspan wrote. “So the only viable option is to decrease the value of that debt by way of monetary debasement. It’s despicable and dangerous, but the only other option is austerity, which is too unpopular for any public servant to mention at this time.”
US Dollar Slides To Lowest Level In 2 Years As Nation Grapples With TrumponomicsFail#
* The US Dollar Index fell to its lowest level since May 2018 on Tuesday as investors grew more bearish toward the currency.
* The gauge has dropped for five days straight amid continued virus risk and fears of new stimulus arriving too late to best aid the economy.
* With short interest in the dollar booming and other countries better handling their outbreaks, the currency stands to fall further before regaining its strength.
* Watch the US Dollar Index update live here.
The greenback slid to a two-year low on Tuesday as investors grew increasingly concerned about how a stimulus deadlock could exacerbate the coronavirus’ economic scarring.
The US Dollar Index – which tracks the dollar’s value against a basket of other currencies – fell as much as 0.8% to its lowest since May 2018. The gauge has fallen for five days straight, bringing its year-to-date drop to around 4.2% as the US continues to grapple with the pandemic.
The dollar began its decline in March as the virus slammed the economy and forced widespread lockdowns. The drop worsened through the summer as premature reopenings kicked off a second wave of infections.
With legislators failing to agree on new fiscal stimulus and outbreaks continuing to cripple economic activity, the US currency stands to worsen compared to nations containing the virus.
“Longer-term, we see dollar weakness as US debt grows, and the global recovery gains momentum. Near term, dollar may strengthen with uncertainty during flu season,” Eric Bright, managing director at Bel Air Investment Advisors, said.
Investors had already been hedging the dollar’s weakness and buying gold, but institutional players are now entering the trade. Hedge funds are net short on the dollar for the first time since May 2018, according to data compiled by Bloomberg.
Such bearish activity could place greater downward pressure on the dollar if other nations rebound faster than the US.
The Dollar Index stood at 92.36 as of 11:50 p.m. ET Tuesday.
A Flexible Fed Means Higher Inflation
Broad thrust of central bank’s new strategy is that it will be even more dovish, and interest rates will stay low for even longer
The Federal Reserve has just given itself a license to do pretty much whatever it wants.
Chairman Jerome Powell will no doubt disagree: His speech on Thursday set out a new target for average inflation of 2%. But because he ruled out any mathematical definition of the average, anything from serious deflation up to inflation of 3.2% over the next five years could count as success.
This isn’t really a problem. The broad thrust of the Fed’s new strategy is that it will be even more dovish, and interest rates will stay low for even longer. But—and it is a vital point—what the Fed is really saying is that we should trust that it won’t let inflation spiral out of control, so any overshoots of 2% won’t last long.
The Fed wants people to believe inflation will be roughly 2% in the long run, and more precision than that isn’t really necessary.
Those who prefer their monetary policy to be governed by rules will be disappointed. The Fed used to let bygones be bygones, ignoring what had happened to inflation in the past as it pursued its goal of 2% in future.
A catch-up strategy means that the failure to hit 2% for most of the past decade could be used to justify inflation above 2% for most of the next decade. The lack of a firm rule, though, means Mr. Powell isn’t tied to having to compensate for any future period above 2% by running below that for a while afterward.
Mr. Powell says the new approach is flexible. He isn’t kidding. Choose your period, and almost anything can be justified. Since 1960, inflation has averaged 3.2% (using the mathematically correct geometric, or compound, average of the Fed’s preferred inflation measure).
A hawk applying a strict policy of inflation averaging could justify aiming for deflation for years to bring the long-term average back down to 2%. Some bygones will still be ignored.
The same mathematical problem bedevils what might appear to be more reasonable approaches. Should the average apply since the Fed adopted its target in 2012? Since Mr. Powell took over in 2018? Since five years ago?
There is no correct answer, and the results are different enough to be significant for policy: Start from 2012, and the next five years need inflation of 3.2% to bring the average up to the goal. Start from Mr. Powell’s appointment, and it needs to be 2.3%, while starting five years ago would require inflation of 2.5%.
Rather than get lost in the math, the Fed’s new policy is just saying that the central bank will be really dovish for a really long time. The dovishness is backed up by a shift on unemployment, too, where low numbers of jobless will no longer prompt pre-emptive action to head off inflation.
Investors heard him, and responded appropriately. Long-dated bond yields jumped as they usually do when rates are cut, as the Fed was no longer expected to choke off a recovery so soon.
It is easy to argue that all this is irrelevant. The Fed is stuck with zero rates, has ruled out going negative and has been slow to set explicit targets for bond yields, something known as yield-curve control. With its inflation measure at just 1% last month, there is little need to worry about what will happen at 2% now.
But it matters for markets, and so for the economy. Thursday’s markets did exactly what Mr. Powell must have been hoping: higher long-dated Treasury yields, but also higher stock prices—with the biggest losers this year turned into winners, and vice versa.
Out of Thursday’s top 100 performers in the S&P 500, all but six had lagged behind the index this year, with the majority falling by double-digit percentages. The reflation trade was back, and showed that investors think the Fed still has power.
Quite how that power will be used is less clear than it was. The new policy means the Fed can more easily justify higher inflation, and surely will. But where it will draw the line remains uncertain. If and when inflation picks up again, working out what “flexible” means will be critical for investors.
Top Fed Official Says New Framework Provides More Humble Approach to Setting Rates
Changes reflect reality that economic models ‘can be and have been wrong,’ says Vice Chairman Richard Clarida.
A top Federal Reserve official said the central bank would resume discussions at its meeting in two weeks over how it could refine its guidance about plans to keep interest rates lower for longer.
Fed Vice Chairman Richard Clarida offered little specifics about what changes might be considered or when they might be unveiled, saying he didn’t want to prejudge the outcome of coming discussions. The Fed’s next policy meeting is Sept. 15-16.
Officials are turning their attention to what ways they can provide more support to the economy after cutting rates to near zero in response to the downturn caused by the coronavirus pandemic in March. They are buying Treasury and mortgage securities at a rate of more than $1 trillion a year and have signaled no interest to raise rates for years.
The coming discussions on how to tweak their asset purchase program or refine their so-called forward guidance about interest rates has been smoothed by the conclusion last week of a yearlong policy revamp in which the Fed will seek periods of slightly higher inflation after periods in which price pressures run below their 2% target.
In remarks Monday, Mr. Clarida said the central bank needed to be more skeptical of models that predict higher inflation when setting interest-rate policy, given the weak response of inflation to lower levels of unemployment over the past decade.
The Fed’s new framework states that the Fed won’t raise interest rates simply because unemployment has fallen to a low level estimated to spur faster price inflation, Mr. Clarida said.
Concerns that too-low levels of unemployment would lead to a surge in inflation led the Fed to very slowly begin raising rates in 2015 after seven years in which rates were pinned near zero.
Mr. Clarida signaled a note of humility in his remarks Monday. The change “reflects the reality that economic models of maximum employment, while essential inputs to monetary policy, can be and have been wrong,” he said.
“A decision to tighten monetary policy based solely on a model without any other evidence of excessive cost-push pressure…is difficult to justify given the significant cost to the economy if the model turns out to be wrong.”
Mr. Clarida said the Fed needed to change its policy-setting framework because officials will have less room to spur growth by cutting interest rates in a world where they are pinned near zero more often.
The Fed formally adopted a 2% inflation target in 2012 but since then has encountered greater challenges boosting inflation because their main policy tool, a short-term benchmark interest rate, has been pinned near zero.
If the central bank targets 2% inflation and consistently falls short, expectations of future inflation will slide, making it much harder to achieve the target, said Mr. Clarida.
The changes adopted last week also effectively raised the Fed’s inflation target by saying the central bank should take past misses of the 2% target into account and seek periods of moderately higher inflation to compensate.
Mr. Clarida said Fed officials believed two tools—forward guidance and asset purchases, which the central bank deployed last decade—would be best suited to provide stimulus after the Fed lowered rates to zero.
Mr. Clarida reaffirmed the Fed’s lack of support to cut rates below zero and said a separate strategy of committing to purchase unlimited amounts of Treasury securities to cap yields remained an option, but one that is on the back-burner.
If forward guidance and other central bank communication is credible, caps would provide only modest benefits. “The approach brings complications in terms of implementation and communication,” said Mr. Clarida. Still, he said, the Fed believed the tool should remain an option “if circumstances change markedly.”
Mr. Clarida, who has led the Fed’s framework review initiated by Chairman Jerome Powell in late 2018, said the central bank’s rate-setting committee will turn its attention at coming policy meetings to possible refinements to other communication tools, including its statement of economic projections. The Fed will try to reach a decision on any changes by December, he said.
Bitcoin Nears $12K As Dollar Declines To 29-Month Low
Bitcoin is drawing bids amid a sell-off in the U.S dollar, with new signs emerging that the largest cryptocurrency is maturing as a global asset class.
* At the time of writing, bitcoin is trading near $11,900 – up 2% on the day. Prices reached a high of $11,964 early Tuesday, according to CoinDesk’s Bitcoin Price Index.
* The dollar index, which gauges the greenback’s value against major currencies, is currently trading 0.4% lower at 91.75, the lowest level since April 2018. The greenback is down more than 10% from highs seen in Mach.
* “From a macro level, the U.S. dollar has continued to fall since [the Federal Reserve’s Jackson Hole meeting], creating a further buying pressure on bitcoin and broader safe-haven commodities such as gold,” Matthew Dibb, co-founder of Stack, a provider of cryptocurrency trackers and index funds, told CoinDesk in a WhatsApp chat.
* Investors are selling dollars, possibly on bets that interest rates in the U.S. would remain low for a long time.
* The Federal Reserve now has the room to hold rates low for a prolonged period, having signaled tolerance for high inflation last week.
* U.S. inflation expectations have continued to strengthen since Fed Chair Jerome Powell’s inflation speech at Jackson Hole last week.
* The 10-year breakeven inflation rate, or the bond market’s expectation of price pressures over the next ten years, rose to 1.8% on Monday, the highest level since Jan. 2, according to the Federal Reserve Bank of St. Louis.
* Long-term inflation expectations have more than tripled in the past 5.5 months to 1.8%.
* Additional bullish pressure for bitcoin may be stemming from ether’s rise to two-year highs near $470.
* “Bitcoin is showing significant strength today on the back of recent gains in ethereum and the broader alternative cryptocurrencies,” Dibb said, citing increased buying in the $12,000 call option expiring in September as evidence of the market’s short-term bullish mood.
* The Singapore-based QCP Capital noted in its Telegram channel that “there was a flurry of put buying on Monday and more of such hedging flows may be seen in the next weeks if bitcon is held below $12,500.”
Jerome Powell Throws Us Dollar Under A Bus In Jackson Hole
Fed Chairman Jerome Powell threw the U.S. dollar under a bus last week at the central bank’s annual Jackson Hole, Wyoming, meeting.
The Economic Policy Symposium hosted annually by the Federal Reserve Bank of Kansas City — an event attended by finance ministers, central bank managers and academics, among others — was held virtually due to COVID-19 concerns this year, and there was little virtual about the announcement. The U.S. dollar would be fed to the wolves.
A Monumental Shift From An Already-Unprecedented Monetary Policy Stance
To be sure, the Fed has persisted with an accommodative monetary policy posture since the Great Recession despite strong years of growth in the middle of the Obama years and sluggish yet consistently positive growth the rest of the time.
Before the coronavirus pandemic, the Fed had begun raising interest rates beyond the zero range, as the need to leave something in the tank should another crisis ensue was acknowledged.
Those moves were roughly in line with growing central banker concerns globally that accommodative monetary policy had failed to generate robust growth rates and risked making central bankers toothless in case a serious recession occur.
What has been little understood through the last two decades is that with Chinese imports raging throughout western markets, deflationary forces were being bought inbound at the same time as labor demand faced unprecedented challenges.
The global economic structure was changing.
Nevertheless, central banks around the world persisted in their efforts to inflate economies and encourage growth — not that there was no growth. In fact, when Powell took over the reins in 2018, the United States was enjoying the longest period of economic expansion in its history. But the growth was sluggish.
Changing Course Just At The Wrong Time
The Federal Reserve had raised rates nine times between 2015 and 2018, with prices stagnating every time it did. That change in direction, however, was soon to be turned on its head courtesy of a 100-year pandemic.
Since the COVID-19 onslaught, the Fed and its counterpart banks slashed rates back down to zero-bound levels, as economies were brought to a standstill. In March, the Fed announced a policy of being prepared to purchase an unlimited amount of treasuries and mortgage-backed securities to shore up financial markets.
Its balance sheet ballooned by over $3 trillion to around $7 trillion with no end in sight. And last week, Powell revealed a much-anticipated stance of “average inflation targeting.” Since 1977, the Fed’s dual mandate has been to maintain maximum employment and stable prices. The latter is considered a 2% inflation rate.
All that changed last Thursday. By targeting average inflation, Powell indicated that the Fed would keep interest rates lower than they needed to be, notwithstanding the health of the economy to push prevailing inflation above 2% if inflation had previously run lower than that for too long.
In today’s context, the picture is frightening. Inflation has run just significantly shy of 2% since the Great Recession. To drag that average up to the target rate retrospectively, Powell and colleagues may be set to target levels around 3% for a prolonged period of time.
What Average Inflation Targeting Could Mean For The Dollar
If the Fed maintains an accommodative monetary posture well into a broader economic recovery, the results will almost undoubtedly be asset bubbles in stocks and housing. That is exactly what happened following the recovery from the Great Recession. In fact, stocks have already proven buoyant since the coronavirus shutdowns, with investors ensured continued asset price support from regulators.
The Wall Street maxim “never bet against the Fed” has never been truer. Wealthy investors, always the first in line for cheap money, stand to gain the most from low-interest rates. The impact of that is bubbles in valued assets like housing that price ordinary homeowners out of the market.
Another obvious peril for the economy is the debasement of the currency. Already, investors and corporations have seen the writing on the wall. MicroStrategy, a publicly-traded business intelligence company, recently swapped its U.S. dollar cash reserves for Bitcoin (BTC) to avoid a balance sheet loss that would result from a falling dollar.
The Winklevoss twins argue that inflation is inevitable. While gold, oil and the U.S. dollar have long been the go-to safe-haven assets, gold and oil are illiquid and difficult to store, and the U.S. dollar is no longer safe as a store of value. They see Bitcoin benefiting enormously from the Fed’s actions.
Don Guo, The Ceo Of Broctagon Fintech Group, Pointed Out:
“Should inflation continue to run high, we can expect many investors to use Bitcoin as a hedge, propelling its price up further. Throughout 2020, numerous analysts have predicted Bitcoin to reach heights that are unheard of, and it is undeniable that the market is in an even stronger position than it was during its 2017 bull run. Since then, the market has matured greatly, with increased institutional involvement and media popularity as a result.”
If inflation appears inevitable to the Winklevoss twins, the Fed has all but guaranteed it. Grayscale recently released a report, arguing:
“Fiat currencies are at risk of debasement, government bonds reflect low or negative real yields, and delivery issues highlight gold’s antiquated role as a safe haven. There are limited options to hedge in an environment characterized by uncertainty.”
Fixed supply assets such as Bitcoin appear primed to triumph from Jerome Powell’s latest set of announcements. As the dollar suffers the fate of significant value debasement at the hands of regulatory overkill, Bitcoin is sure to emerge as a winner.
22% Of All Us Dollars Were Printed In 2020
$9 Trillion in Stimulus Injections: The Fed’s 2020 Pump Eclipses Two Centuries of USD Creation.
Since September 2019, research shows the Federal Reserve has pumped over $9 trillion to primary dealers by leveraging enormous emergency repo operations. A recently published investigative report shows the U.S. central bank submits the daily loan tally, but the Fed will not provide the public with information concerning the recipients. Estimates say, in 2020 alone, the U.S. has created 22% of all the USD issued since the birth of the nation.
The U.S. Federal Reserve has printed massive amounts of funds in 2020 and bailed out Wall Street’s special interests during the last seven months. On October 3, 2020, Redditors from the subreddit r/btc shared a video called “Is Hyperinflation Coming?” and discussed how the U.S. central bank has created 22% of all the USD ever printed this year alone.
“The U.S. dollar has been around for over 200 years and for the bulk of that time, it was backed by gold,” one Reddit user wrote on Saturday. He added:
Having a quarter of all USD printed in a single year is more than alarming, it’s mind-blowing.
Additionally, on October 1, 2020, Wall Street on Parade’s (WSP) Pam Martens and Russ Martens published a comprehensive report on how the U.S. central bank pumped out “more than $9 trillion in bailouts since September.” The findings show that the Fed is also getting market advice from Wall Street hedge funds like Frontpoint. The hedge fund Frontpoint Partners is a controversial firm because it shorted the subprime mortgage market during the 2007 to 2010 financial crisis.
The latest WSP analysis shows that the Fed has been “conducting meetings with hedge funds” like Frontpoint in order to get the financial institution’s “input on the markets.” In 2007 to 2010, the Fed was leading a group of lending facilities and once again the central bank is working with three major emergency lending facilities: the Money Market Mutual Fund Liquidity Facility; the Primary Dealer Credit Facility; and the Commercial Paper Funding Facility.
“On top of those facilities, beginning on September 17, 2019 – months before the first case of Covid-19 was reported in the United States – the New York Fed embarked on a massive emergency repo loan operation, which had reached $6 trillion cumulatively in loans by January 6,” the WSP findings detail. The Martens’ also state:
The Fed has provided data on the total amounts of the daily loans, but not the names of the recipients. All it will say is that the loans are going to its 24 primary dealers, which are the trading units of the big banks on Wall Street. The last time we tallied its data in March, it had sluiced over $9 trillion cumulatively to these trading houses.
A number of people believe that the massive creation of money stemming from the Fed will eventually cause hyperinflation. The dollar has lost considerable value since the introduction of the central bank in 1913. For instance, the cumulative rate of inflation since 1913 is around 2,525.4%. This means a product purchased for $1 in 1913 would cost $26.25 in October 2020.
Precious metals and cryptocurrency proponents believe the central bank’s pumping will bolster assets like bitcoin and gold. Pantera Capital CEO Dan Morehead explained in July that the company believes cryptocurrencies like bitcoin (BTC) will help people with the gloomy economic outcome.
“The United States printed more money in June than in the first two centuries after its founding,” Morehead wrote in a letter to investors. “Last month the U.S. budget deficit — $864 billion — was larger than the total debt incurred from 1776 through the end of 1979.”
On the same day Pantera Capital published the letter called “Two Centuries Of Debt In One Month,” the 22-year congressional veteran, Ron Paul, told the public that Americans should be “prepared.”
Paul has exposed the U.S. Federal Reserve for the last two decades and has written extensively about the central bank’s fraud. In the video, the former congressional leader said the medical community, U.S. bureaucrats, and the Fed have done things he never expected.
“After so many years in Washington, I thought I was immune to being shocked by what our government does,” Paul detailed. “But the actions that our elected officials… the Fed… even the medical community have taken in the past few weeks have gone beyond anything I could have imagined.”
“Most Americans will be blindsided by what’s going to happen. Make sure you, your family, and anyone you care about are prepared,” the former U.S. Presidential candidate insisted.
Meanwhile, the U.S. airline industry is looking for a second bailout, three days ago the number of the country’s mortgages involved in the bailout program spiked by 21,000, the hotel industry is looking for stimulus, and President Trump recently revealed a multi-billion dollar farm bailout.
A Weakening U.S. Dollar Is Still The Preeminent Currency
The greenback has depreciated 11% from its March peak, but it has a long way to go before it gives up its reserve status.
In early June, the U.S. dollar appeared to be in total free fall. From May 14 through June 8, the Bloomberg Dollar Spot Index tumbled 4.6%, effectively wiping out all of its appreciation during the worst of the coronavirus crisis. A Bloomberg Opinion column from Stephen Roach, former chairman of Morgan Stanley Asia, declared: “A Crash in the Dollar Is Coming.” He got a lot of pushback.
Depending on how you define a “crash,” it certainly looks as if the Yale University faculty member had the direction right. The Bloomberg dollar index is down an additional 3.7% since then, well below its moving averages and dangerously close to breaking through a key intraday level that could give traders scope to push it lower by at least 2% more.
The four-year chart, which captures the ups and downs of the foreign-exchange market since President Donald Trump was elected, looks rather ominous.
Yet when evaluating the dollar on a 10-year time horizon, the greenback’s move over the past several months looks less like a crash and more like a simple unwind of the haven flows during the height of the Covid-19 pandemic, combined with a natural weakening given the Federal Reserve’s relatively more aggressive monetary policy response compared with its global central bank peers.
When thinking about the fate of the U.S. dollar, it’s crucial to separate an extended decline in the greenback’s exchange rate from the prospect of America losing its place as issuer of the world’s primary reserve currency.
These are distinct outcomes with drastically different implications. The former is hardly unusual, given that the dollar has historically fluctuated in multiyear cycles since the early 1970s. The latter would represent a seismic shift in the structure of the global financial system.
Simply put, it’s in no country’s or region’s best interest (at least not imminently) for the U.S. dollar lose its place as the reserve currency of choice. That means the dollar will retain its place on the global stage no matter how weak it might get in the months to come. But make no mistake: There are any number of reasons to bet that the greenback will slide further.
Most obviously, the dollar tends to appreciate when U.S. interest rates climb and weaken when they fall. Short-term Treasury yields are pinned near zero and are expected to stay there for years, while longer-term yields have increased somewhat but remain near all-time lows.
There’s also the well-known fact that the federal budget deficit has ballooned this year in response to the Covid-19 pandemic. Traders widely expect that large shortfalls will continue in the year ahead, particularly if the Democratic Party sweeps the White House and both chambers of Congress, as polls indicate.
Either way, America’s so-called twin deficits — in both its current account and budget — are so extreme that a regression analysis from Bloomberg News’s Cameron Crise projects a 31% decline over the next two years in the ICE U.S. Dollar Index, known as DXY. There’d certainly be no hyperbole in calling that a “crash.”
It’s hard to imagine that sort of precipitous decline happening, however, without an exogenous shock that’s separate and distinct from interest rates and deficits. My Bloomberg Opinion colleague Noah Smith posited last month that a complete breakdown in America’s institutions could be that force:
Urban chaos, violent conflict and uncertainty over who will control the country in the coming years make for a very bad business environment. In a worst-case scenario, businesses and investors could decide the U.S. is a failing state and that their money is best kept elsewhere, at least until things quiet down.
The result could be an unprecedented capital flight — money stampeding out of one of the world’s largest economies and abandoning the reserve currency at the same time. That would probably mean a dollar crash, a surge of U.S. inflation and destabilizing flows of hot money into Europe, Japan, Canada, Australia, South Korea and other, more stable developed nations.
Suffice it to say, that sort of dystopian outlook probably shouldn’t be anyone’s base-case scenario for how the next few months will unfold in the foreign-exchange market.
Indeed, speculative U.S. dollar traders recently turned positive on the greenback for the first time in four months, with net noncommercial positions in DXY futures rising above zero for the first time since June, according to Commodity Futures Trading Commission data.
While that’s hardly a decidedly bullish position, it at least suggests a sizable pool of money will take the other side of the dollar doomsday narrative.
The most likely path for the dollar remains lower, though it stands to reason that traders want to get through the U.S. elections before going out on a limb. Both a “blue wave” and a contested presidency could send the greenback spiraling.
Some, like Roach, would argue that another four years of a Trump administration and its protectionist trade policies and withdrawal from crucial global agreements would also erode the dollar’s value because the rest of the world sees America as an unreliable global leader. On the other hand, a clean Joe Biden victory combined with a Republican Senate and Democratic House could mean gridlock and comparatively tame budget deficits.
But even if the dollar falls 2%, 5% or even 20% more — which would put it near its post-2008 crisis low — it’s not an existential threat as long as the greenback holds onto its “exorbitant privilege.” It’s not particularly close to giving that up, with International Monetary Fund data showing $6.8 trillion of FX reserves held in dollars compared with $2.2 trillion in euros, $625 billion in yen and $486 billion in pounds.
So don’t sweat the continued slide in the dollar too much. Whether considered weak or strong, it’s poised to remain the epicenter of the financial world for many years to come.
Mexico Senate Passes Bill To Make the Central Bank Buy Unwanted Dollars
Mexico’s Senate approved Wednesday a bill that will force the central bank to buy dollars from banks that can’t place them elsewhere, ignoring concerns from policy makers that the bill could make the bank take illegal drug money.
Lawmakers brought the bill to a vote, only hours after top members of the country’s bank association had warned that the bill threatened the autonomy of the central bank and could expose it to sanctions for money laundering if it was approved. The bill goes on to the lower house for a debate and vote.
The legislation would force the central bank to buy up foreign currency from local banks, who end up with excess dollars from cash remittances and tourism. Lawmakers introduced a tweak to the original bill, presented by Morena Senate leader Ricardo Monreal, that said Banxico would not have to buy dollars from any one on government black lists.
Monreal said the bill was needed to help migrants who return for the holidays with wads of cash. “This is no attack on central bank autonomy,” he said. “Banco de Mexico has to be less conservative.”
Banxico said in a statement late Wednesday that senators had ignored its input, and noted the changes to the bill did not ease its concerns.
Following money laundering allegations against HSBC Holdings Inc. and Wachovia Corp. over a decade ago, U.S. banks have increasingly severed relationships with Mexican institutions to protect themselves from potential sanctions.
That is not much of a problem for the global banks operating in Mexico like Banco Bilbao Vizcaya Argentaria SA or Citigroup Inc., but it crimps business by Mexican banks, which can’t easily unload dollars.
Opposition lawmakers said the bill had been forced through the Senate by President Andres Manuel Lopez Obrador’s Morena party without listening to the concerns of the central bank. The bill was introduced, unexpectedly, late last month.
Senator Emilio Alvarez Icaza, an independent, said the bill would turn Banxico into “a money launderer.”
Alvarez said lobbyists of Grupo Salinas had pushed lawmakers to approve the bill. “Is this bill dedicated to one of the president’s special allies to whom he wants to do a favor?” Alvarez said. Grupo Salinas is controlled by Mexico’s third-richest man, billionaire Ricardo Salinas, whose Banco Azteca has played a key role in disbursing Lopez Obrador’s cash aid programs.
Grupo Salinas spokesman Luciano Pascoe said in a text message that the group did “not have any comments on the rumors a senator spreads.”
Even Senator Nancy de la Sierra, a member of the ruling party coalition, said the issue of migrant remittances was used to justify the bill, though such cash remittances are minimal.
Central bank board member Gerardo Esquivel, who has supported the ruling party coalition, said the bill’s passage “puts international reserves at risk while attacking the Bank of Mexico’s autonomy.” Writing on Twitter, he said he hopes the lower house “corrects this situation.”
Earlier Wednesday, Eduardo Osuna, CEO of BBVA Mexico, and Barclay’s country chief Raul Martinez-Ostos had criticized the bill. Luis Nino, president of Mexico’s bank group ABM and the chairman of Banco Azteca, said that Mexican banks had solid anti-money laundering protocols in place and that it was not the place of ABM to reject legislative proposals.
In a separate vote Wednesday evening, the Senate also ratified the president’s nomination of Finance Ministry treasurer Galia Borja Gomez as a member of the central bank board. Former Economy Minister Graciela Marquez was also approved to the board of the national statistics agency.
Mexico Working On Alternative To Bill That Would Force Central Bank To Buy Dollars
Controversy around the bill led the government to seek a way to help migrants change dollars while protecting the Bank of Mexico’s autonomy.
The Mexican government is preparing a banking product to help migrant workers change their dollars as an alternative to a bill in Congress that would put the responsibility for excess foreign cash on the central bank, Mexico’s top finance official said.
The bill passed last month by the Senate would require the Bank of Mexico to take dollars and other foreign currency in cash that commercial banks are unable to put into the financial system, but the lower house postponed a vote on the legislation after a flurry of criticism.
The central bank said the bill if passed would violate its constitutional autonomy, and international ratings firms said it could undermine Mexico’s financial credibility.
Mexico has limits on the amount of foreign currency that individuals and businesses can deposit in cash, as part of measures to combat the laundering of illicit funds. But of the $4.7 billion of foreign currency received in cash in the first nine months of 2020, banks were able to place with clients in Mexico or repatriate through U.S. correspondent banks all but $102 million.
Proponents of the bill, lawmakers of President Andrés Manuel López Obrador’s Morena party, said it seeks to benefit Mexicans who receive remittances or tourist dollars in cash but can’t exchange them for pesos or are forced to exchange them at unfavorable rates.
But the Bank of Mexico argued the bill would put the country’s $195 billion in foreign reserves at risk because the central bank could end up buying dollars from illicit sources.
The bill is in the lower house but it is still pending, and we think that it isn’t necessary if we can come up with the right solution.
— Mexican Finance Minister Arturo Herrera
The controversy led the government to develop a new banking product that could work well for migrants, and at the same time protect the central bank’s autonomy, Finance Minister Arturo Herrera said in an interview.
“The bill is in the lower house but it is still pending, and we think that it isn’t necessary if we can come up with the right solution,” he said.
Mr. Herrera said Mexican migrants in the U.S. would be able to open an account at Banco del Bienestar, a state development bank focused on serving lower-income sectors of the population, so that they can change their dollars at competitive exchange rates when they return to their hometowns.
Migrants could open an account at the bank using a consular identification, which is available to Mexicans abroad regardless of their migratory status, and relatives in Mexico could also use the accounts.
Authorities are still identifying specific regions in Mexico where the problem of exchanging dollars is especially acute, and teams from the finance ministry plan to visit rural communities in the coming days to finalize the plan, Mr. Herrera said. The product could be available in a matter of weeks.
It is unclear if the government plan would satisfy legislators who favor the bill. Lower house majority leader Ignacio Mier didn’t immediately reply to a call seeking comment.
Mr. López Obrador, whose party has a majority in both chambers of Congress, said Wednesday that he favored an agreement to solve the problem of migrants’ dollars without encroaching on central bank independence or causing conflict with international financial institutions.
“What’s needed is a formula, and I’m sure this can be done, without affecting the Bank of Mexico’s autonomy,” he said. “It’s in all our interests.”
The Bank of Mexico, one of the most orthodox in Latin America, has been a pillar of Mexico’s financial stability since it was granted autonomy in 1994 after a series of fiscal crises and peso devaluations that devastated the economy.
Mr. Herrera appeared confident that lawmakers would acquiesce.
“There was never an intention to affect the central bank’s autonomy, but to resolve this problem with the migrants,” he said. “As long as we deal with that, the other part [regarding the central bank] is not necessary.”
If the bill were dropped, it would likely give support to the Mexican peso, which is trading at its strongest level against the U.S. dollar in nearly a year.
The proposed legal changes were widely seen by economists as one of the most anti-market actions under Mr. López Obrador’s two-year-old administration.
Relations with investors have soured since the administration canceled a partially built $13 billion Mexico City airport project, renegotiated several gas pipeline contracts with private firms, and put up obstacles to private investors in the oil and electricity industries.
Financial authorities say only a small number of Mexicans are unable to exchange dollars, most of them migrants who return to rural areas with no banking infrastructure. Workers in tourist resorts such as Cancún often receive dollars in cash, and sometimes don’t have access to fair exchange rates.
Fed Reinforces Plans To Provide Open-Ended Stimulus To Spur Recovery
Most central bank officials project interest rates will remain near zero for at least three years.
Federal Reserve officials put the final touches Wednesday on a monthslong effort to clarify their plans to support the economy for longer than they have following prior downturns, concluding one of the most active years in the central bank’s history.
Fed officials slashed their short-term interest rate to near zero in March as the coronavirus pandemic disrupted financial markets and the economy. They also launched an array of emergency lending programs and began large-scale purchases of government debt and mortgage securities.
On Wednesday, officials updated their formal guidance around how long those purchases would continue, complementing an earlier pledge in September that set a higher bar to raise interest rates.
The Fed has been buying $80 billion in Treasurys and $40 billion in mortgage bonds a month since June while pledging to maintain those purchases “over coming months.”
On Wednesday, the central bank stated those purchases would continue “until substantial further progress has been made” toward broader employment and inflation goals. Officials don’t expect to reach those goals for years, according to projections they released Wednesday.
“Together these measures will ensure that monetary policy will continue to deliver powerful support for the economy until the recovery is complete,” Fed Chairman Jerome Powell said at a news conference after Wednesday’s meeting.
The projections show most officials thought they would hold short-term rates near zero for least three more years despite a somewhat more optimistic economic outlook than they had in September, before drugmakers had developed highly effective Covid-19 vaccines.
Many officials projected such low rates would be needed even though they projected inflation would be at the Fed’s 2% target and unemployment would fall below 4% by the end of 2023. Those projections reflect a change in the central bank’s framework adopted this summer that took a more relaxed view toward inflation.
Mr. Powell said the central bank expected to see some one-time increases in prices of goods and services due to a rebound in activity from the pandemic next year but that they were unlikely by themselves to create self-sustaining inflationary forces.
“It’s not going to be easy to have inflation move up,” said Mr. Powell. “We’re honest with ourselves and with you in the [projections] that even with the very high level of accommodation that we’re providing…it will take some time.”
With interest rates pinned near zero, the asset purchases have become the primary lever with which officials could dial up or down their stimulus.
The goal of the Fed’s new guidance is to avoid the kind of market backlash that occurred in 2013, when then-Chairman Ben Bernanke suggested the central bank might soon taper its asset purchases.
Investors thought the Fed was accelerating its plans to raise interest rates, sparking a sudden one-percentage-point jump in the 10-year Treasury yield that became known as the “taper tantrum.”
Some analysts have said that communicating the Fed’s intentions earlier would reduce the chance of any perception later that it was abruptly tightening monetary policy.
“They’ll be buying assets for a fair while. Even if everyone expected this, it’s useful because it keeps people from getting the wrong idea,” said William English, a former senior Fed economist who now teaches at Yale University.
How effective has the Fed’s communication around its policy strategy been this year? Join the conversation below.
Mr. Powell said when the Fed believes it is close to meeting its new benchmark of substantial progress, “we will say so, undoubtedly, well in advance of any time when we would actually consider gradually tapering the pace of purchases.”
For the next few months, risks to growth are rising amid an increase in Covid-19 cases, hospitalizations and deaths. Claims for unemployment benefits jumped last week, and the Commerce Department reported Wednesday that a measure of purchases at stores, restaurants and online dropped a seasonally adjusted 1.1% in November from the prior month.
At the same time, Fed policy makers have been surprised through the late summer and early fall by the degree that economic activity held up despite worse-than-expected public-health conditions.
In recent weeks, investors have focused on whether the Fed might change the composition of its holdings by buying more Treasury securities with longer-term yields to hold those yields down, as it did during bond-buying programs last decade. Some analysts said such additional stimulus would provide added insurance against the risks to the economy from rising coronavirus cases and business restrictions.
Mr. Powell said the Fed didn’t think those charges were appropriate now because long-term rates are already very low, boosting sectors of the economy such as housing.
“Interest-sensitive parts of the economy, they’re performing well,” he said. “The parts that are not performing well are not struggling from high interest rates. They’re struggling from exposure to Covid.”
Mr. Powell said any near-term deterioration in the economic recovery would be better addressed by direct spending by Congress and the White House, not changes in interest-rate policy, particularly because it takes time for monetary policy changes to affect the economy.
The prospect of widespread vaccinations by the middle of the next year meant that “the economy should be performing strongly” by the second half of next year, Mr. Powell said.
Vaccines allow the Fed “to look through the near-term weakness, as bad as it is, because you are more confident about where the economy’s going to be six months from now—and that is what is relevant for your decision,” said Lewis Alexander, chief U.S. economist at Nomura Securities.
Bipartisan talks in the Senate have created optimism that Congress could approve a coronavirus-relief legislative package of around $900 billion before it adjourns for the year.
Since the spring, Mr. Powell has compared the government’s economic policy response to building a bridge across a chasm. “For many Americans, that bridge is there and they’re across it,” he said. But others still don’t have a bridge, including 10 million jobless workers who were employed earlier this year and small businesses unable to function because of the pandemic.
With vaccines providing more visibility about where the end of the bridge might be, “it would be bad to see people losing their business, their life’s work in many cases, because they couldn’t last another few months,” he said.
The U.S. Dollar Is Getting Crushed. Falling Below 90 For First Time Since April 2018
The U.S. dollar fell sharply versus major currencies Thursday, with bears taking the Federal Reserve’s reassurance that it won’t be soon tapering its bond purchases as a green light to sell the currency.
“The latest blow to the dollar came from the Fed, which vowed not to touch policy even if the outlook for the U.S. economy brightens as it now expects,” said Joe Manimbo, senior analyst at Western Union Business Solutions.
Weakness also reflected rising expectations that Washington lawmakers will finally agree on an economic rescue package that’s seen as necessary to shore up a sagging recovery, he said.
The ICE U.S. Dollar Index DXY, -0.72%, which measures the currency against a basket of six major rivals, slumped 0.7% to 89.828, trading below 90 for the first time since April 2018. It’s down 6.8% so far this year.
Moreover, the index has dropped nearly 13% since March, when it spiked to a more-than-three-year high as the COVID-19 pandemic plunged the U.S. economy into recession and sparked a bout of chaos in financial markets, driving global investors into the safety of the world’s reserve currency.
The Dollar’s Selloff On Thursday Was Broad:
* The euro EURUSD, the most heavily weighted component of the DXY, rose 0.6% to $1.2270, hitting its highest level versus the dollar since April 2018. For the year to date, the shared currency is up more than 9%.
* The dollar fell to a more-than-three-year low versus the Japanese currency USDJPY, -0.35%, declining 0.4% to ¥103.07.
* The British pound GBPUSD, 0.49% was up 0.5% at $1.3575, its highest since April 2018.
* Currencies that typically rally in line with equities, commodities and other assets perceived as risky were doing just that, with the Australian dollar AUDUSD, 0.67% and the New Zealand dollar NZDUSD, 0.53% each up 0.6% versus their U.S. counterpart. The dollar was off 0.1% versus the Canadian dollar USDCAD, -0.16%.
U.S. stocks pushed higher Thursday, with the S&P 500 SPX, +0.58%, Dow Jones Industrial Average DJIA, +0.49%, and Nasdaq Composite COMP, 0.84% closing at records.
A falling dollar is typically seen as a positive for U.S. and global equities as well as the world economy. It’s also seen as the potential missing ingredient for a bullish turnabout in commodities priced in the dollar.
The Fed, in its last policy meeting of 2020, on Wednesday reassured investors the central bank would maintain its easy monetary policy stance, including its bond-buying program, until the economy shows “substantial progress” toward recovering from the damage inflicted by the virus.
Fed Chairman Jerome Powell, in his news conference, indicated the central bank wouldn’t be hasty in unwinding its monetary stimulus measures even though the central bank’s economic forecasts appeared a bit more upbeat than previous iterations.
“The FOMC’s dot-plot looked hawkish…Mr. Powell’s comments were anything but,” wrote Kit Juckes, global macro strategist at Société Générale, referring to the individual rate forecasts produced by members of the policy-setting Federal Open Market Committee.
Of course, other central banks are also employing extraordinary measures aimed at supporting their economies. And while a weaker dollar is viewed as generally positive for the U.S. and global economy, it’s been a source of consternation for some rivals, including the European Central Bank.
But an important part of the tale centers on interest rates — particularly the differential between yields on bonds in the U.S. and elsewhere. While Treasurys still yield more than, say German government debt, that differential has shrunk, reducing the incentive to hold U.S. paper and weakening a source of support for the dollar.
The spread between U.S. TMUBMUSD02Y, 0.125% and German two-year yields TMBMKDE-02Y, -0.723% has narrowed from 215 basis points, or 2.15 percentage points, to around 90 basis points this year, noted Mark Haefele, chief investment officer for UBS Global Wealth Management.
Dollar weakness “also reflects the improved prospects for more pro-cyclical currencies amid recent positive vaccine news and a corresponding decline in demand for safe-haven assets,” he said, in a Thursday note, referring to the dollar’s tendency to find support during periods of turmoil.
“Meanwhile, the prospect for further U.S. fiscal stimulus, with Congress continuing to debate the details of a $900 billion COVID-19 aid bill, is likely to keep U.S. indebtedness in focus, adding to pressure on the greenback,” Haefele said.
Add in improving prospects for a trade deal between the European Union and the U.K., a compromise last week that unblocked the path to a $2.2 trillion EU recovery fund, and the continued rollout of COVID-19 vaccines and the stage is set for the dollar to keep falling, Juckes wrote.
“The only problem is that it’s falling too fast,” he said, noting that SocGen’s fourth-quarter euro forecast put the shared currency at $1.27, around 4% above its current level. The euro has risen around 3% in the last month alone.
Dollar On The Ropes
U.S. stocks climbed, with small-cap shares outperforming in one of the final trading sessions of 2020. The dollar continued its slide, weakening to the lowest in 2 1/2 years.
Automakers were among the best performers as the S&P 500 Index edged higher, while the Russell 2000 gauge of smaller companies rallied about 1% for its biggest gain in almost two weeks.
Travel and leisure companies rose in Europe after the U.K. approved a coronavirus shot by AstraZeneca Plc and the University of Oxford, offsetting pessimism sparked by a slower-than-planned rollout of shots in the U.S. Volumes were light during the holiday week, with trading in S&P 500 shares about 25% below the 30-day average. Bitcoin extended its record-breaking rally as it approached $29,000.
Investors have pushed stocks to sky-high valuations this year on expectations that widespread vaccine distribution in 2021 will reignite economic growth and boost corporate profits. The U.S. government has started sending Americans $600 payments for pandemic relief, but discouraging news came from Texas, where at least three shipments of Moderna Inc.’s vaccine arrived with signs that the shots had strayed from their required temperature range.
“Investors continue to weigh stimulus hopes against negative pandemic developments,” Tom Essaye, a former Merrill Lynch trader who founded “The Sevens Report” newsletter, wrote to clients. “Markets have aggressively priced in a lot of positive resolution to these events (and more) in 2021.”
With a volatile year coming to a close, risk assets such as stocks, corporate bonds and Bitcoin are sitting at or near record highs. The MSCI World Index of global stocks is set to end the year about 14% higher, having surged almost 68% since its March low.
On the coronavirus front, daily deaths in Germany surpassed 1,000 for the first time since the outbreak began, with a record increase in the last 24 hours. A Chinese state-backed vaccine developer said one of its shots prevents Covid-19 in almost 80% of people. U.S. President-elect Joe Biden criticized vaccine-distribution efforts under President Trump as too slow.
Elsewhere, Bloomberg’s dollar gauge fell to its lowest since April 2018 as traders squared currency positions ahead of the year’s end amid thin liquidity.
China’s Rapid Recovery Puts Global Dollar Hegemony In Doubt
China’s light-speed recovery from the pandemic has reignited the perennial debate about how long the dollar’s 50-year dominance of global markets can persist.
The U.S.’s struggle to control the coronavirus and revive its economy contrasts sharply with the Asian nation, where growth has roared back. That divergence — which saw the greenback’s worst performance since 2017 as the yuan advanced — has bolstered China’s tilt at dollar hegemony, with investors flocking to onshore assets, trying out the renminbi for trade, and even giving it another look as a reserve currency.
The dollar’s demise as the world’s reserve currency has been idly speculated on and predicted for years, of course. Prior to the yuan, all the hype was about the euro as the dollar’s successor.
Nothing, though, ever managed to dent the twin forces underpinning dollar supremacy: the U.S.’s role as both global growth engine and haven of first choice for investors during crises. So powerful were these two pillars that they were given a catchy nickname in trading circles years ago — the “dollar smile.”
But recently, that smile has looked more like a smirk, with the virus eroding both of the currency’s traditional supports. Instead, it’s the yuan that’s benefiting from demand for economic outperformance, and for assets insulated from the pandemic’s fallout, bringing the currency’s long-term prospects back into focus.
“The center of the world’s economy is shifting from the Northern Atlantic, where it’s been for 500 years, to the Pacific,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “The currency markets are going to reflect that over time.”
It’s a somewhat ironic end to President Donald Trump’s pursuit of a weaker dollar. Despite frequently admonishing Beijing officials for keeping a lid on their currency to support Chinese exports at the expense of the U.S. — and starting a full-blown trade war to force their hand — it took a pandemic to change the tide.
China is reaping the rewards. The world’s second-largest economy is now set to depose the U.S. as the leading engine of growth in 2028, five years earlier than expected just a year ago after better weathering the pandemic, the Centre for Economics and Business Research said last month.
While American output is poised to rebound in 2021, growing 3.9%, China is on track to expand more than 8%. And its central bank is considering tightening monetary policy — in stark contrast with a pledge from the Federal Reserve to remain accommodative, which has helped drag down the dollar.
In fact, some see China’s economic success itself — particularly in becoming a linchpin of the global supply chain — reinforcing the trend for low interest rates elsewhere, and increasing the divergence.
“The U.S. and other countries remain reliant on the Chinese supply chain to control the pandemic while vaccinations are rolled out,” said Ben Emons, the managing director of macro strategy at Medley Global Advisors. That advantage is what “keeps G-10 central banks highly accommodative.”
Investors have certainly taken notice, pumping $135 billion into Chinese bonds in the 12 months ended Sept. 30, data compiled by Bloomberg show. Equities have also proved popular, luring $155 billion over the same period. While recent New York Stock Exchange confusion around delisting several Chinese companies served as a reminder of the regulatory and trade-related risks surrounding the nation’s assets, investors were largely unfazed.
Ultimately, it’s the record cache of negative-yielding assets elsewhere in the world that has made Chinese debt particularly appealing. China’s 10-year bonds yield more than 3%, versus just over 1% for similar-maturity Treasuries. With these securities also joining a growing number of international benchmarks that help investors set their return objectives, the renminbi is getting another look as a currency for both short- and long-term commitments.
While more than 60% of the world’s currency reserves are denominated in dollars — as they have been for over two decades — holdings of the greenback fell to the lowest since 1996 at the end of the third quarter. The euro, pound and yen have gained from this decline, yet only the yuan has seen allocations increase — to 2.1% — for the last three quarters.
That has some analysts rethinking their approach to the currency. HSBC Holdings Plc sees the yuan increasingly influencing weekly price changes in the pound and commodity-linked currencies, while strategists at Societe Generale SA see it affecting risk sentiment.
The currency is now the fifth-most used currency for global payments, accounting for about 2% of transactions, according to data from the Society for Worldwide Interbank Financial Telecommunications, which handles cross-border payment messages for more than 11,000 financial institutions in 200 countries. While that’s still a small share, when Swift first started tracking currencies in this way in 2010, the renminbi was ranked 35th.
Of course, the investor frenzy for all things China comes with a big caveat: Those flows could push the yuan to strengthen too far, too fast, and precipitate government intervention to stop gains hurting exports. Officials have historically advocated for a weaker currency to support manufacturers.
Indeed, Citigroup Inc. is predicting the currency could soar to its strongest in almost three decades versus the dollar in 2021, Goldman Sachs Group Inc. forecasts a rise to levels unseen since 2015, and JPMorgan Chase & Co. describes bets on the renminbi as one of its “highest conviction” picks for this year.
It wouldn’t be the first time that officials have acted to stem appreciation. In 2015, Beijing unexpectedly devalued the currency, triggering the yuan’s biggest one-day loss in 20 years. So far, China’s central bank has only moved to slow, rather than halt, the yuan’s advance by making it cheaper for traders to bet against the currency and by relaxing capital curbs to allow more outflows.
But if the currency rises to less desirable levels, policy makers could act more forcibly. They could also delay opening domestic markets further — a prerequisite for the yuan to become a truly global currency.
“Locally, the momentum of FX actions suggest a desire for a slower pace of RMB appreciation,” Nomura strategists including Craig Chan wrote in a December report.
Any intervention would slow not only the yuan’s advance, but also its challenge to the dollar. Despite bullish calls for the yuan from some of the finance industry’s biggest names, the median forecast is for an advance of less than 1% by the currency in 2021. That would lag expected gains of more than 3% for the ruble and over 6% for the Brazilian real, data compiled by Bloomberg show.
Dollar hegemony could also find an ally in former Fed Chair Janet Yellen, who’s President-Elect Joe Biden’s pick to helm the Treasury department. The incoming administration could once again promote a stronger dollar, rebooting a policy that had held since 1995 until fizzling during the Trump presidency.
Still, the uptick in appetite for Chinese assets suggests growing international comfort with the renminbi, and the nation’s economic outperformance is likely to drive further use — even if the greenback remains the dominant currency for trade, capital markets and reserves for some years to come.
“We are extremely bullish on emerging markets, which is fundamentally based on the view the Chinese economy will be strong in 2021 and that China has done a great job dealing with the virus,” said John Malloy, portfolio manager and co-head of the emerging and frontier market team that oversees $10 billion at RWC Partners. “There will be continued pressure on the yuan to strengthen.”
Dollar Shorts Mount Before Yellen Outlines Market-Based Policy
Investors may take Janet Yellen’s expected endorsement of a market-driven exchange rate as an additional green light for the U.S. currency’s long-term downtrend.
The U.S. Treasury Secretary-designate will affirm the U.S.’s commitment to a market-determined dollar value on Tuesday, the Wall Street Journal reported. The comments could fuel speculation authorities will not object to a softer greenback, which earlier this month fell to a two-year low against its major peers.
Investors are already doubling down on wagers that stand to profit if the currency weakens further, emboldened by an incoming Democratic administration that is prepared to unleash more fiscal stimulus to help the economy recover. The bets come despite a reprieve over the past few weeks that has driven the Bloomberg Dollar Index higher along with Treasury yields.
“We interpret Yellen’s view to mean the U.S. government is unlikely to stand in the way of an ongoing market-driven dollar depreciation,” said Rodrigo Catril, currency strategist at National Australia Bank Ltd. in Sydney. There’s “no challenge to the current dollar downtrend.”
Hedge funds boosted net short positions to the highest in nearly three years in the week through Jan. 12, according to data aggregated from the Commodity Futures Trading Commission. Meanwhile, they raised bullish bets on the pound to the most since October, and are wagering on the euro and the Australian and New Zealand currencies to rise.
The U.S. adopted a policy of favoring a “strong” dollar in 1995. While the mantra evolved from one Treasury chief to another, no administration from then until the Trump years communicated, as the president did in 2017, that the dollar was “getting too strong.”
“This is not the same as the strong-dollar policy of the past,” Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd., said of Yellen’s expected upcoming remarks. “A commitment to market-determined exchange rates implies that the new administration will be comfortable with further dollar weakness.”
While the dollar’s recent gains have spurred talk of a sustained rebound, Goldman Sachs Group Inc. and investors in a Bank of America Corp. survey remain steadfast in forecasting a weaker greenback. The Bloomberg Dollar Spot Index has climbed more than 1% from a low in January, extending gains to touch a one-week high on Monday amid fading global risk appetite.
“We continue to believe that the combination of high dollar valuations, low nominal and real rates, and a rapid recovery in the global economy will weigh on the greenback throughout 2021,” Goldman strategists including Danny Suwanapruti wrote in a Jan. 17 note.
Options prices also suggest the bounce back in the dollar is in its final stages. The spread between one-year and one-month risk reversals, a gauge of market sentiment, has again turned negative — a pattern that has preceded a fall in the spot market multiple times since September.
“The dollar is still likely to move lower over the course of the year,” Seamus Mac Gorain, head of global rates at JPMorgan Asset Management, said in an interview last week. “Many of the currencies which are more levered to global growth, particularly emerging market currencies” and the Aussie are set to strengthen, he said.
Global Food Prices At Six-Year High Are Set To Keep On Climbing #GotBitcoin
Global food prices reached a six-year high in December and are likely to keep rising into 2021, adding to pressure on household budgets while hunger surges around the world.
A United Nations gauge of food prices has jumped 18% since May, as adverse weather, government measures to safeguard supplies and robust demand helped fuel rallies across agricultural commodities from grains to palm oil. Prices will likely climb further, the UN’s Food & Agriculture Organization said.
The spike threatens to push up broader inflation, making it harder for central banks to provide more stimulus to shore up economies, while stirring memories of food-price crises a decade ago. It’s bad news for consumers whose incomes have been hurt by the Covid-19 crisis, and adds to concerns about global food security that’s being affected by conflicts and weather shocks.
“We do at this point see more factors pushing up global food prices,” said Abdolreza Abbassian, a senior economist at the FAO. “Food inflation is a reality. While people have lost income, they are as we speak going through a tremendously difficult hardship.”
Corn and soy futures rallied to six-year highs as drought threatens crops in South America at a time of surging Chinese demand, while palm oil — used in about half of all supermarket goods — is near a 10-year high. Protectionist measures are also propping up markets, with Argentinian farmers planning a protest strike after the government suspended corn-export licenses, while wheat giant Russia will curb grain exports from mid-February to tame food inflation.
Commodities priced in dollars — often seen as a hedge against inflation — should remain supported as the greenback falls further this year, Abbassian said. Plus, an economic recovery in some parts of the world will probably fuel consumer spending and food demand, with weather risks and export restrictions from some grain suppliers aiding prices in the short term, he said.
Weather concerns, government intervention and strong exports to China could push agricultural markets higher this year, according to Rabobank International. Soy prices have become expensive enough that the world will need to ration demand, Joe Stone, head of crop merchant Cargill Inc.’s agriculture supply chain and corporate trading, said this week.
The FAO’s food price index has risen for the past seven months, with annual prices capping the highest average in three years. Still, costs remain well below peaks in 2008 and 2011, when soaring prices caused political and economic instability around the world and grain-export bans tightened supply.
“Commodity price inflation is very real, but we’re still nothing like a decade ago,” said Tim Benton, research director in emerging risks at Chatham House in London. “I am reasonably confident that it’s not going to lead to big things as per a decade ago. But still, Covid has the potential to upset things in terms of flows of goods, in terms of access to labor.”
The Chapwood Index
The Chapwood Index reflects the true cost-of-living increase in America. Updated and released twice a year, it reports the unadjusted actual cost and price fluctuation of the top 500 items on which Americans spend their after-tax dollars in the 50 largest cities in the nation.
The Real Cost of Living Increase Index
It exposes why middle-class Americans — salaried workers who are given routine pay hikes and retirees who depend on annual increases in their corporate pension and Social Security payments — can’t maintain their standard of living. Plainly and simply, the Index shows that their income can’t keep up with their expenses, and it explains why they increasingly have to turn to the government for entitlements to bail them out.
It’s because salary and benefit increases are pegged to the Consumer Price Index (CPI), which for more than a century has purported to reflect the fluctuation in prices for a typical “basket of goods” in American cities — but which actually hasn’t done that for more than 30 years.
The middle class has seen its purchasing power decline dramatically in the last three decades, forcing more and more people to seek entitlements when their savings are gone. And as long as pay raises and benefit increases are tied to a false CPI, this trend will continue.
The myth that the CPI represents the increase in our cost of living is why the Chapwood Index was created. What differentiates it from the CPI is simple, but critically important. The Chapwood Index:
* Reports The Actual Price Increase Of The 500 Items On Which Most Americans Spend Their After-Tax Money. No Gimmicks, No Alterations, No Seasonal Adjustments; Just Real Prices.
* Shines A Spotlight On The Inaccuracy Of The CPI, Which Is Destroying The Economic And Emotional Fiber Of Our Country.
* Shows How Our Dependence On The CPI Is Killing Our Middle Class And Why Citizens Increasingly Are Depending Upon Government Entitlement Programs To Bail Them Out.
* Claims To Persuade Americans To Become Better-Educated Consumers And To Take Control Of Their Spending Habits And Personal Finances.
The inaccuracy of the CPI began in 1983, during a time of rampant inflation, when the U.S. Bureau of Labor Statistics began to cook the books on its calculation in order to curb the increase in Social Security and federal pension payments.
But the change affected more than entitlements. Because increases in corporate salaries and retirement benefits have traditionally been tied to the CPI, the change affected everything. And now, 30 years later, everyone knows the long-term results.
Ask anyone who relies on a salary or Social Security or a pension and he’ll tell you his annual increase in income doesn’t come close to his increase in expenses. What comes in is less than what goes out — a situation that spells disaster for average Americans.
* The data solidly supports what many Americans have suspected for years. The CPI no longer measures the true increase required to maintain a constant standard of living. This is the main reason that more people are falling behind financially, and why more Americans rely on government entitlement programs.
Chapwood Index Founder Ed Butowsky
Butowsky began calculating the Chapwood Index in 2008. Using social media, he surveyed his friends across the country to determine what they bought with their after-tax income. He narrowed the list down to the most frequent 500 items and asked his friends in America’s 50 largest cities to check the prices on those items periodically. The Index shows the fluctuation in each city in the cost of items such as:
Starbucks coffee, Advil, insurance, gasoline, sales and income taxes, tolls, fast food restaurants, toothpaste, oil changes, car washes, pizza, cable TV and Internet service, cellphone service, dry cleaning, movie tickets, cosmetics, gym memberships, home repairs, piano lessons, laundry detergent, light bulbs, school supplies, parking meters, pet food, underwear and People magazine.
The Index forces middle-class Americans to recognize that their dependence on income increases pegged to the much-lower CPI virtually guarantees that they will run out of money before they die, because people are living longer and there is a huge difference between the CPI and the real world.
As an example, the CPI rose 0.8 percent in 2014. But in Boston, the Chapwood Index shows that the real cost of living increase was 10.7 percent. This means that if you work in the Boston area and got an 0.8 percent raise in your salary, it wasn’t nearly enough to cover the increase in your day-to-day expenses.
The unintended consequence of the CPI is that people who depend on Social Security and pensions don’t get what they need. Our hope is that people will review the Index, see what the real cost of living is where they live and understand that it leaves them exposed, and consult with a financial adviser to plan for the future.
It was especially bad in San Jose, CA , where the Chapwood Index shows a 13.7 percent rise in the cost of living. Even the city with the lowest increase, Colorado Springs, CO , showed a 6.6 percent rise, a 5.8 percent higher than the CPI.
So, wherever you live, you showed a higher income. But at the end of the year, you spent all of it — and more.
Grantham Warns of Biden Stimulus Further Inflating Epic Bubble
In the waning days of Donald Trump’s presidency, Jeremy Grantham warned that U.S. stocks were in an epic bubble. He now predicts Joe Biden’s economic-recovery plan will propel them to perilous new heights, followed by an inevitable crash.
“We will have a few weeks of extra money and a few weeks of putting your last, desperate chips into the game, and then an even more spectacular bust,” Grantham, the value-investing legend and co-founder of Boston-based GMO, said in a Bloomberg “Front Row” interview. “When you have reached this level of obvious super-enthusiasm, the bubble has always, without exception, broken in the next few months, not a few years.”
Data show risk-taking exploded following the last round of pandemic-relief checks. Grantham has “no doubt” at least some of the $1.9 trillion in federal aid Biden is seeking from Congress will end up being spent on stocks instead of food or shelter.
He envisions a collapse rivaling the 1929 crash or the dot-com bust of 2000, when the Nasdaq Composite Index plunged almost 80% in 31 months.
Many investors argue today’s valuations are justified by the growth potential of transformative technologies and new business models. Grantham, 82, dismisses that argument as fanciful, and he rejects the popular theory that the Federal Reserve can cushion or even reverse the next slide with bond-buying that pumps more liquidity into financial markets.
“At the lowest rates in history, you don’t have a lot in the bank to throw on the table, do you?” he said.
For now, however, stocks keep rising to records and Grantham’s reputation as a perma-bear who misses out on rallies only grows.
GMO’s cautious stance has been costly. Assets under management fell by tens of billions of dollars during the decade-long bull market, as the firm steered clear of growth stocks. Then in April, GMO doubled down, insulating its portfolios from directional bets on the market and largely missing out on the second leg of the 2020 rebound.
Even before the pandemic, Grantham thought the economy was on shaky ground. He was concerned about the steady decline in U.S. productivity, skeptical that Fed policy had achieved much beyond widening the inequality gap and worried that the profit-at-all-costs nature of American capitalism was destroying the environment and fraying the social fabric.
For Grantham, the combination of fiscal stimulus and emergency Fed programs led to “spectacular excesses” and pushed an already overvalued market into bubble territory.
It could have other consequences, too.
“If you think you live in a world where output doesn’t matter and you can just create paper, sooner or later you’re going to do the impossible, and that is bring back inflation,” Grantham said. “Interest rates are paper. Credit is paper. Real life is factories and workers and output, and we are not looking at increased output.”
Grantham, who considers himself a student of bubbles, has been right before — if early. GMO exited Japan in 1987 and reduced its exposure to U.S. stocks in late 1997, dodging the dot-com wipeout. Grantham also raised concerns about housing prices ahead of the 2008 financial crisis.
This time, there may be few places to hide. If Grantham is right about the threat of inflation, bonds are risky. He also has reservations about gold because it generates no income. And in his view Bitcoin is make-believe nonsense.
Selling everything and holding cash is one option. But Grantham said his best advice for long-term investors is to focus on low-growth stocks that are cheap relative to benchmark indexes, emerging markets and companies fighting climate change with renewable energy and electric-car technology.
“You will not make a handsome 10- or 20-year return from U.S. growth stocks,” he said. “If you could do emerging, low-growth and green, you might get the jackpot.”
Fed Chair Powell: ‘We’d Welcome Higher Inflation’
The central bank doesn’t want to pull back asset purchases just yet, Powell said Wednesday.
U.S. Federal Reserve officials voted Wednesday to keep monetary conditions at historically loose levels while waiting for the economy to heal.
Chairman Jerome Powell said he doesn’t want to put a timeline on tapering the U.S. central bank’s $120 billion-a-month in asset purchases.
“In terms of tapering it’s just premature,” Powell said. “We said we’d want to see substantial, further progress towards our goals before we modify our asset purchase guidance. It’s just too early to be talking about dates. We need to see actual progress.”
A little bit of inflation in 2021 would be welcome news for the Federal Reserve if it means fewer jobs are permanently lost, Powell added.
“I’m much more worried about falling short of a complete recovery and losing people’s careers and lives that they built because they don’t get back to work in time,” Powell said. “I’m much more concerned about that than the possibility which exists of higher inflation. … Frankly, we’d welcome higher inflation.”
This might be welcome news for bitcoin’s true believers.
The Federal Open Market Committee (FOMC) will keep the target rate for federal funds in a range of 0% to 0.25%, and the Fed plans to keep buying $80 billion of U.S. Treasury bonds and $40 billion of agency mortgage-backed securities every month.
The committee noted that “the pace of the recovery in economic activity and employment has moderated in recent months,” but that it would continue accommodative monetary policy until inflation averages 2% over time.
The market didn’t budge at the news. The S&P 500 has been on a steady downward trajectory for most of the day and has fallen by more than 2%. Bitcoin was up a mere 1% since Powell’s comments.
The comments were in line with recent observations from economists who believe the Fed plans to let the economy run hot until sectors hard-hit by the pandemic reopen.
Powell did not address Vice Chair Richard Clarida’s comments earlier this year stating that the Fed would have to see inflation at 2% for a year before raising rates.
“Because inflation has been running persistently below 2%, we’d like to see it run moderately above 2% for some time,” Powell said. “We have not adopted a formula, we’re not going to adopt a formula. … We’re going to preserve an element of judgement.”
The only time bitcoin (BTC, -3.59%) came up during the meeting was in a question from CNBC’s senior economics reporter Steve Liesman who asked the chair if low interest rates were pushing up asset prices and creating a bubble that could cause economic fallout. Powell responded by saying that “financial stability vulnerabilities overall are moderate.”
Rising Food Prices Risk Making The Covid Hunger Crisis Worse
Soaring costs for food staples are hitting at a time when some countries can ill afford it, risking exacerbating inequalities wrought by the Covid-19 pandemic.
A gauge of global food prices has climbed to a six-year high and may have further to run as a Chinese crop-buying spree and adverse weather bolsters markets. While costs remain below peaks seen in 2008 and 2011, the bigger bills come as economies grapple with the fallout from the coronavirus crisis, with millions out of work, tourism scarce and remittances low.
That’s stretching budgets in import-dependent countries and also making it costlier to provide food aid, said Arif Husain, chief economist at the United Nations’ World Food Programme in Rome. Protectionist policies emerging in key agricultural suppliers like Russia — buoying wheat prices– are also spurring worries about a potential “copycat effect” if other shippers follow, he said.
“For places which are already suppressed and depressed in the sense of economic activity, it’s going to be quite troubling,” Husain said in an interview.
Last year, even as food supplies appeared ample, the WFP warned that 270 million people faced hunger across the countries it operates in. That’s an increase of more than 80% from before the pandemic began. Since then, the International Grains Council has pared its estimate of global stockpiles to a five-year low, and prices are also picking up for vegetable oils and dairy.
The pandemic risks increasing economic inequality in nearly every country at once, the first time that’s happened in records spanning a century, charity Oxfam said this week. In tandem, nations including Venezuela, Zambia and Ghana are facing rapid food inflation.
The WFP, the recipient of last year’s Nobel Peace Prize, has appealed for about $15 billion to provide aid in 2021. The current situation is different than previous crises like 2008, when buyers were squeezed by rising costs for both food and fuel, Husain said.
“This is really a different kind of double whammy,” he said. “You’re not only getting hit by the supply-side issues and constraints, but also on the demand side because purchasing power has disappeared.”
U.S. Farmers Won’t See Profits Like 2020 For Decade, USDA Says
U.S. farmers won’t see another year as profitable as 2020 for at least a decade, the U.S. Department of Agriculture projected Tuesday.
Farm profits soared to their highest level in seven years amid a flood of government aid related to the pandemic and the trade war, with direct federal assistance payments accounting for more than a third of U.S. farmers’ $121.1 billion in net income last year.
Despite a continuous rise in sales through 2030, the USDA forecast profits would be lower, dropping to $100.1 billion this year and then fluctuating in a range between $99.3 billion and $109.8 billion through 2030.
The USDA projections assume no change in current government policy, though the Biden administration has suggested it is considering payments to farmers to encourage climate-friendly practices. The trade bailout isn’t scheduled to continue without new action from the president or Congress, nor are the pandemic relief measures.
U.S agricultural exports are forecast to rise 12% for the federal fiscal year ended Sept. 30, driven by higher prices and larger quantities as global demand strengthens. Shipment value is projected to surpass a record set in 2014 by the following year and continue upward for the remainder of the decade.
Reflation Trade Is Back In Focus As The Ruckus Over Reddit Fades
Now that the Reddit rumble is out of the way, it seems investors are getting back to focusing on the key market strategy of recent months: the reflation trade.
Cyclical stocks are retracing some of their recent weakness against defensives, U.S. inflation expectations have pushed higher and a section of the Treasury yield curve is at the steepest since 2016.
Supportive U.S. economic data, expanding pandemic vaccination programs and signs of progress on President Joe Biden’s $1.9 trillion stimulus plan have rekindled enthusiasm for bets linked to higher prices and growth.
“It’s back to a broad thematic market focus on ‘reflation’ potentials,” wrote Nomura Holdings Inc. strategist Charlie McElligott in a note to clients Tuesday. “Sneaky ‘upside inflation surprise’ data in the past two days has to be highlighted, as it was likely ‘lost in the wash’ of the Wallstreetbets and institutional de-grossing mania.”
Here’s A Look At Some Of The Recent Drivers And Market Moves Linked To The Reflation Trade:
Institute for Supply Management data released Monday not only showed that manufacturing remained robust in January but also that prices paid for raw materials rose to their highest since April 2011. That helped push U.S. 5-year breakeven rates — a gauge of inflation expectations — to an eight-year high.
Despite limited moves in benchmark Treasuries in recent days, longer-dated bonds have come under more pressure, leading to a steepening in the yield curve. The spread between five and 30-year Treasuries has hit its steepest since 2016.
“The U.S. 5s versus 30 Treasury curve is breaking higher, steadfastly portraying inflation,” wrote Chris Weston, head of research at Pepperstone Group Ltd. in Melbourne, in a note Wednesday. “In the bond market we trust.”
The surge in price swings caused by the recent retail trading frenzy initially triggered a rush out of cyclical stocks to defensives as investors sought havens. But that move has begun to reverse amid receding concerns that the speculative mania would cause an extended selloff. A basket of cyclical stocks from Goldman Sachs Group Inc. has outperformed its defensive counterpart by over one percentage point so far this week, and remains in a relative uptrend.
Still, some investors think much good news on the reflation front is already priced into markets, and continue to worry about signs of froth in risk assets. Strategists at Unigestion, the $22 billion Swiss investment manager, recently “neutralised” its bet on reflation, despite keeping a positive medium-term view on global equities.
“The significant increase in breakevens in the U.S. as well as the performance of cyclical commodities in January have validated our reflation bet and led us to take our profits,” the strategists wrote in a note Monday. “On the macro front everything looks solid, but beneath the surface we see some signs of irrational exuberance.”
The Reflation Trade: What Is It?
As calendars have turned to 2021, headlines have trumpeted the “reflation trade.” This is not new. Talk of reflation is very common as markets rebound from a major pullback. Even so, it’s been a while since our last major downturn, which may beg the question, what is reflation, and what does the reflation trade mean for the markets?
What is Reflation?
Reflation encompasses policies aimed at increasing prices in order to achieve economic growth and full employment. Think of it as purposefully trying to increase inflation to stated targets (in the US, the general stated policy from the Fed is to aim for 2% inflation).
G.D.H. Cole once noted that “Reflation may be defined as inflation deliberately undertaken to relieve a depression.” In order to create reflation, policymakers use either fiscal or monetary policy to expand output and combat deflation, or forces that may be driving prices down. Reflation as a policy aim usually comes out of a recession or other period of economic uncertainty.
Common Tools Utilized:
Lowering Interest Rates
Increasing The Money Supply (I.E., Printing More Money)
What Is The Reflation Trade?
The reflation trade, broadly speaking, is trading into sectors that expect to be positively impacted by the policy tools mentioned above. This can take place throughout the financial markets, but we will focus on stocks and bonds.
On the stock side, sectors that tend to perform well in a reflationary environment are cyclical and value stocks that historically outperform during market recoveries. Financials, energy and small stocks may be expected to do well as governments push to get economies restarted with the global rollout of the vaccine.
One could argue this dynamic already began in the 4th quarter of 2020, with energy, financials and especially small stocks outperforming the broader market. However, these types of stocks still are trading at a discount versus their more growthy counterparts. These sectors also are typically overrepresented in value portfolios, which helps explain why value tends to outperform in economic recoveries.
With policymakers sending out another round of stimulus and the Federal Reserve continuing to keep interest rates on the floor, there appears to be continued opportunity in these value sectors as the reflation dynamic continues to play out. As we’ve discussed before, valuations for stocks matter.
It’s just a matter of when they start to matter. This reflation concept may be the catalyst to see investor preference change from what has worked (like growth, US stocks, and big stocks) to other parts of the market that are key to a good, diversified portfolio.
In the bond world, investors expect interest rates to rise in a reflationary environment, so they’ll sell old bonds at lower yields in favor of bonds with higher yields. Since the yields on 10-year treasuries bottomed out in August at nearly 0.5%, they have inched upwards, closing out 2020 at 0.93%.
While many commentators cast some doubt for a major resurgence in bond yields, most expect them to continue to creep up. The likely expectation in this type of environment is bonds can muddle along slowly, which is not unique to the history of bonds. Like the famous childhood story, bonds are much more like the tortoise than the hare.
What Does this Mean In 2021?
As we look into the new year, how does reflation impact your portfolio? Well, as governments continue to cope with the damage wrought to economies by the Covid-19 pandemic, the tools they are using are largely reflationary.
The Federal Reserve has kept rates at zero, and Congress has passed legislation that injected trillions of fiscal stimulus into the US economy. These measures could very well lead to the reflation trade into small and value stocks to continue to add to the edge they started having last quarter.
Rising Inflation Will Force The Fed’s Hand
The Fed has created the biggest financial bubble in history, but rising prices will require a fundamental rethink of monetary policy.
The problems faced by new U.S. President Joe Biden would be formidable for anyone. There’s the political schism that won’t be cured by optimistic calls for unity. Then there’s the herculean challenge of stopping Covid from killing too many more people.
High up on his list, and sooner rather than later, will be dealing with the consequences of the biggest financial bubble in U.S. history. Why the biggest? Because it encompasses not just stocks but pretty much every other financial asset too. And for that, you may thank the Federal Reserve.
The fallout from a Fed that has encouraged investors into buying horribly overpriced assets will be every bit as difficult as coming off the gold standard in the early 1970s or tackling runaway inflation in the early 1980s. It will require an act of political will and a complete rethink of monetary policy.
Having Janet Yellen, a former Fed chair, as Treasury Secretary is unlikely to help. She was among a long line of Fed bosses, from Alan Greenspan on, who reacted to each crisis by slashing interest rates and, over the last decade or so, massively expanding the Fed’s balance sheet.
By coming to the rescue every time in the manner it did, the Federal Reserve created the conditions for the current bubble — and the next crisis.
That game is now over. Little noticed last week amid the copious commentary on the GameStop Corp. jollity was a data release showing the Fed’s preferred measure of consumer inflation is going up. Over the past 12 months core personal consumption expenditure rose 1.5%, higher than the 1.3% expected.
Admittedly this is still low, but it’s likely to go up a lot further. The Fed is monetizing much of the government deficit; the monster amount of money that it created is finding its way out of the banking system; there are severe supply constraints in both manufacturing and services; and Asia is on fire.
The charts below are revealing. Sean Wolpert, a former colleague of mine at Rubicon Fund Management, has compared the price pressures in the two ISM surveys (manufacturing and non-manufacturing) with subsequent CPI. Even without a sharp recovery in demand, inflation is already rising and these two surveys are a very good predictor of where it will go next.
Rapidly rising inflation will eventually force the Fed to rein in its lax monetary policy. But it will move, by its own admission, very slowly; on my interpretation much too slowly. It’s a racing certainty that markets will be spooked much earlier than the central bank.
Central bankers the world over seem to be the only people who don’t see signs of wild excess wherever they look. Most investments are almost certainly going to lose money over the next few years.
On the measures that matter — you know, the ones that actually predict returns — the U.S. stock market is as expensive as it was in 1929, 2001 and the lead up to the Global Financial Crisis.
All stock-market bubbles go hand in hand with rapid credit growth and this latest one is no exception. Non-financial corporate debt has been on a tear these few years past, relative to gross domestic product. Part of the reason last year, of course, was the rapid fall in GDP, although the Fed also played its part by buying billions of dollars of corporate debt.
At least when stock markets went south in those earlier periods, investors could plonk their money in government debt because they offered yields. In the early 1990s, lest we forget, Japanese 10-year yields briefly touched 8%. They don’t have quaint things like interest rates in Europe or Japan any more, thanks to their respective central banks. The 1.1% available on 10-year U.S. Treasuries looks breathtakingly meager, too.
It’s probably an even worse idea for investors to buy corporate debt, especially lower-rated issuance. Spreads on company debt over government bonds are also desperately low, meaning corporate debt yields are at record lows. Yields on borrowers rated CCC or less — the lowest ranks of junk before default — have never been lower.
If investors are about to face a crisis, so too is the White House and the Fed. It wouldn’t take much movement from the Fed to upset the markets, hence its desire to move carefully. On the other hand, doing nothing is also problematic from a political perspective. Inflation is regressive: It hurts poor people far more than rich ones. That doesn’t look like a model of social justice.
Reasonable people can disagree, but I think we’ll find out how much of a hole the Fed has dug for itself, markets and the U.S. in the next three months.
Great Reflation Trade Brings New Threats To The Stock Rally
For the first time in a long time, there’s a conversation on Wall Street about when equities might start to feel the heat from reflation signals in the bond market.
Powered by a rally in oil and bets on further U.S. stimulus, market-derived inflation expectations are near the highest since 2013.
For now, traders bidding up stocks at records are in a sweet spot with the pandemic recovery projected to boost corporate earnings.
But the recent sell-off in benchmark nominal bonds is reminding investors that faster economic growth brings the risk of higher borrowing costs.
Strategists from Jefferies Group LLC to Goldman Sachs Group Inc. are already turning their attention to the next chapter in the fraught relationship between bonds and risk assets.
“As the market prices in these developments, ‘long-duration’ growth and expensive high-profitability stocks will likely be pressured,” said Jim Solloway, chief market strategist at the investment management unit at SEI Investments Co.
A disappointing jobs report released Friday was taken as yet another sign President Joe Biden will prevail in pushing through his stimulus package. Treasury Secretary Janet Yellen added fuel to the reflationary fire on Sunday, stating that the U.S. can return to full employment in 2022 with enough fiscal support.
All that sent bond yields higher across the globe Monday trading, before moves whipsawed in New York trading. The S&P 500 Index rose 0.7% to an all-time high.
UBS Group AG analysts see the pain threshold for stocks as a 10-year Treasury yield of 2%. That’s a long way from the current level of around 1.17%, especially while an accommodative Federal Reserve is seen capping rates.
Yet there are straightforward reasons to worry that higher rates will undercut equity allocations. Right now, more than 60% of S&P 500 constituents have a dividend yield above the 10-year Treasury yield. But if the latter climbs to 1.75% by year-end as they expect, that percentage will fall to just 44%, Bank of America Corp. strategists warn.
Another way to consider the relative appeal of equities is the gap between the S&P 500’s earnings yield and 10-year Treasury rates. While that has narrowed to the least since 2018, at 2 percentage points it’s still well above the long-term average.
Faster earnings growth, which in turn supports improving shareholder payouts, could outweigh the drag from higher yields. Among firms that have reported fourth-quarter earnings, 81% have beat estimates, according to Jefferies.
“Higher yields do not beget lower equity share prices if earnings are being revised up just as quickly,” strategists led by Sean Darby wrote in a note.
Another pressure point to consider is interest rates adjusted for inflation, which have staged a big decline since the pandemic to spur stocks higher through the recession.
With the recent plunge in bonds mostly driven by higher inflation expectations, real rates — as proxied by bond yields minus breakeven rates — haven’t budged that much. That’s good news for stock investors, since the link between the S&P 500 and inflation bets has been consistently positive since 2012, according to strategists at Goldman Sachs.
“Improving growth expectations often correspond with higher breakeven inflation, rising earnings expectations, and improving investor sentiment, which more than offset the higher discount rate,” a team led by Ryan Hammond wrote in a Sunday note.
Better economic expectations typically help sectors more sensitive to the business cycle like banks and commodities, which tend to fall under the category of value stocks.
JPMorgan Chase & Co. strategists in a note told clients to add domestic value sectors like financials and telecoms.
When interest rates rise, investors also typically prefer the near-term cash flows offered by these cyclical shares, rather than stocks with secular growth — like Big Tech — since their long term profits get discounted at higher rates.
Yet megacaps this cycle are in fighting form. The Nasdaq 100 has still managed to narrowly beat the Russell 3000 since bond yields bottomed out from early August.
So while tech belongs to the growth investing style that tends to underperform when rates rise, Goldman strategists argue these days the cohort might be an exception to that rule.
“Their secular and idiosyncratic growth profiles mean that changes in interest rates are unlikely to be a major driver of returns,” they wrote.
30-Year Treasuries At 2% Are Just A Distraction
The real noteworthy action is showing up in the market for inflation-protected securities.
The world’s biggest bond market has hit another round-number milestone. The 30-year U.S. Treasury yield reached 2% on Monday for the first time in almost a year, before the Covid-19 pandemic sent markets into a whirlwind.
As far as psychological levels go, this is somewhat exciting for the $21 trillion Treasury market, arguably on par with when the benchmark 10-year yield reached 1% in early January. In both cases, yields jumped higher for clear fundamental reasons.
The 10-year note breached 1% after a Democratic sweep of the Georgia Senate runoff races, which gave the party ever-so-slight control of the chamber and therefore boosted the chances of a unified government pushing through additional fiscal stimulus.
The 30-year bond eclipsed 2% in no small part thanks to that outcome, with Vice President Kamala Harris casting the tiebreaking vote last week that progressed President Joe Biden’s $1.9 trillion relief package.
It’s tempting to place heavy significance on 30-year yields reaching 2% because it’s the same as the Federal Reserve’s inflation target. Yes, the central bank has recently adopted “flexible average inflation targeting” to allow for periods of overshooting 2% to make up for persistent misses. But it’s still effectively the guidepost for the Fed’s price-stability mandate, even if it’s more of a moving target than before.
Yet when looking at the entire U.S. Treasury market, including inflation-linked securities, it’s clear that a more significant 2% threshold was cleared weeks ago by a range of maturities that are arguably more telling about the economic outlook than the nominal 30-year bond.
For instance, the 10-year breakeven rate, which reflects the difference between 10-year Treasuries and their inflation-protected counterparts, touched 2.216% on Monday, the highest since August 2014. It first crossed 2% on Jan. 4, even before the Georgia runoffs tilted the calculus around fiscal stimulus.
While the latest move is partially a reflection of rising crude oil prices — a big component of the consumer price index to which Treasury Inflation Protected Securities are linked — the trend higher has been practically nonstop for the past nine months.
As the bond market’s 10-year inflation expectations have climbed, the benchmark nominal 10-year Treasury yield has kept pace. It reached as high as 1.198% on Monday, the highest since a burst of volatility sent yields soaring in March. This kind of parallel move is normal, even if the real yield is still historically low around -1%.
What’s happening in shorter-maturity Treasuries, by contrast, is anything but typical. As I’ve laid out before, the simple equation that represents the connection between nominal yields, real yields and breakeven rates is the following:
Real Yield = Nominal Yield – Breakeven Rate
Since Nov. 10, the five-year Treasury yield has increased by less than 2 basis points to 0.472% from 0.454%. During that same period, the five-year breakeven rate has surged 64 basis points to 2.326% from 1.686%. Per the above equation, that quashed the inflation-adjusted real yield; at -1.895%, it’s at an all-time low.
Two-year real yields are also at a stunning record low of -2.466%. Not only are inflation expectations picking up for the next 24 months, but nominal two-year yields have tumbled to record lows in recent weeks, including hitting 0.1012% on Monday because of a confluence of technical factors at the front end of the yield curve that have sent investors scrambling for a place to park extra cash.
So, to summarize, the bond market is indicating that inflation will run at almost 2.5% on average over the next two years and 2.32% over the next five. And yet nominal Treasuries with those maturities aren’t budging, locking any buyers into even more negative expected returns when adjusting for expected inflation. What gives?
Simply put, this behavior should confirm to Federal Reserve officials that bond traders have received their message loud and clear about the central bank’s commitment to unanchor inflation expectations and keep an accommodative monetary policy stance until it sees clear evidence of price growth exceeding 2% and the labor market approaching full employment.
For months now, even as inflation expectations have soared, investors have simply refused to price in more than one full rate increase through 2026. That’s a telling shift in how markets interpret this Fed’s reaction function.
All the ups and downs of the 30-year yield, by comparison, can arguably be written off as mostly a distraction. After all, does anyone truly know the precise expected return on a bond backed by the U.S. government that doesn’t mature for three decades?
Thirty-year Treasuries span multiple economic cycles and are subject to structural forces that don’t just change overnight or even with one administration.
So instead of scrutinizing the long bond, watch the interplay between inflation expectations for the coming years and nominal Treasury yields. The Labor Department will release January CPI data on Wednesday, with a median estimate of 1.5% year-over-year growth in a Bloomberg survey.
That would be a 10-month high, though well below the Fed’s target (and it prefers a different gauge anyway). Still, Fed Chair Jerome Powell has sought to head off any narrative of resurgent price growth, noting at a press conference last month that the coming months’ rise in inflation will be transient.
Judging by breakeven rates, bond traders aren’t too sure about that. But they’re also not about to test Powell’s resolve to keep interest rates near zero for as long as it takes. As captivating as it is to watch long-term nominal yields rise from record lows, the persistent decline in short-term real yields is the bigger story.
George Shultz Understood That Money Was Power
Replacing the Bretton Woods system was as important as military might in defeating the Soviet Union.
George Shultz, who died on Sunday at age 100, never enjoyed the same mystique as a George Kennan or Henry Kissinger. Yet he had every bit as strong a claim to being America’s greatest strategist of the post-World War II era.
The former secretary of state helped the U.S. solve three great strategic problems of the late 20th century. In doing so, he also helped catapult America from the malaise of the 1970s to the dominance of the post-Cold War era, and he left a legacy that remains relevant today.
It can be hard to remember now just how bad America’s position seemed in the 1970s. The U.S.-led Bretton Woods system of international finance had collapsed; the West faced prolonged economic stagnation and turmoil. The Soviet Union appeared ascendant in the arms race and the developing world. Democracy was reeling from the political and economic stresses of the modern age.
But by the late 1980s, the Cold War was ending on American terms, democracy was spreading like wildfire, and the U.S. was moving into a new era of economic primacy. Shultz made three signal contributions to this recovery.
First, Shultz revived American economic power for an age of globalization. As secretary of the Treasury between 1972 and 1974, Shultz — along with Undersecretary Paul Volcker — convinced Richard Nixon to stop trying to recreate a system of fixed exchange rates after the fall of Bretton Woods, opting instead for the floating exchange rates we still have today.
That shift initially added to international economic instability. But over the longer term, it liberated capital flows that Bretton Woods had constrained, turbocharging the arrival of financial globalization.
It freed the U.S. from the burden of keeping its currency artificially overvalued and its exports overpriced. And because America had the world’s most attractive capital markets, it allowed the U.S. to pull in vast sums of foreign investment in subsequent decades, buoying the domestic economy while letting Washington live beyond its means by drawing on the savings of foreigners.
Shultz, as much as anyone else, was the author of the move to a more open global economy — and to a system that sustained U.S. economic leadership through the end of the Cold War and beyond.
Second, as secretary of State under Ronald Reagan, Shultz helped power the democratic renaissance by reconnecting American values to American strategy. After the Vietnam War, there had been sharp debates about whether promoting democracy and human rights was a way of advancing U.S. interests or a potentially fatal distraction from them.
The Jimmy Carter administration’s human rights policies had inadvertently destabilized repressive yet friendly regimes in Nicaragua and Iran, making democratic idealism seem like geopolitical naivete.
In a series of brilliant speeches, Shultz explained why Washington had a compelling strategic interest in promoting its ideological values: because democratic legitimacy would make allies in the developing world more resilient against communist subversion; because the U.S. would enjoy stronger bonds with countries whose political systems were not abhorrent to American moral sensibilities; and because a totalitarian superpower, the Soviet Union, would see its influence and appeal shrivel in a democratic world.
Responding to the errors of the Carter years, Shultz’s State Department then led the administration in developing an approach that linked democratic ambition to diplomatic prudence.
The U.S. would work with repressive security services in countries such as El Salvador, while encouraging governments to defang communist insurgencies through far-reaching political reforms.
It would use human rights and democracy as a hammer against repressive Soviet client states, such as Nicaragua and Poland. And it would focus on supporting democratic transitions in countries where a moderate, noncommunist opposition was pushing for change.
Over the course of the 1980s, this strategy assisted democratic breakthroughs in at least a dozen countries, from South Korea to Chile. The Reagan administration remains the exemplar of a strategically savvy approach to promoting American values.
Finally, Shultz helped solve the problem of bringing a long great-power rivalry to an end. When Shultz became secretary of State, the Reagan administration was ramping up pressure on a declining, overextended rival militarily, ideologically and economically. In doing so, it also drove up Cold War tensions to dangerous heights.
The superpower conflict seemed as stalemated as ever in the early 1980s. Shultz’s contribution was in translating the geopolitical leverage Washington had built into a historic reduction of tensions on America’s terms.
Shultz encouraged Reagan to keep turning the screws on Moscow. “The strategic reality of leverage,” he commented, “comes from creating facts in support of our overall design.” But he also understood that Soviet President Mikhail Gorbachev would only make the concessions Reagan sought — in the arms race, the developing world and even Moscow’s treatment of its own citizens — if Reagan built a climate of diplomatic engagement and reassurance with a congenitally insecure regime.
During the late 1980s, Reagan would use American strength and Soviet decline to push Gorbachev toward a series of historic retreats, such as the Soviet withdrawal from Afghanistan and the conclusion of the Intermediate-Range Nuclear Forces Treaty, while using summitry and personal diplomacy to help the Soviet leader portray those retreats as triumphs of enlightened statecraft.
If the Cold War was mostly over by the time Shultz and Reagan left office in 1989, it was in no small part because they had so deftly combined the hard line with the soft touch.
Circumstances change, but some lessons are timeless. U.S. global power still rests as much on its financial advantages as its military and diplomatic might. Promoting American values remains central to advancing American interests, but only if done in a strategically sensible way.
Successful diplomacy with rival powers still requires enough pressure to make concessions seem necessary and enough conciliation to make accommodation seem like an acceptable option. Shultz’s contributions to an earlier era of American renewal have much to teach us as the U.S. faces a new slate of geopolitical challenges today.
Inflation Risk Is Rising. Here’s How To Protect Your Investment Portfolio
Do you need to start preparing your portfolio for rising prices? It’s a question that’s being hotly debated in financial circles at the moment.
With a new U.S. administration looking to spend big and propel a economic recovery, and the Federal Reserve determined to hold off on raising interest rates until a rebound is well underway, financial markets predict U.S. inflation will drift up to a little over 2%. A gentle uptick is expected in other developed economies as well.
Some economists worry though current forecasts are too sanguine.
Investors Are Expecting A Moderate Rise In Inflation Over The Next Five Years
They’re concerned that the combination of a big increase in money supply, central banks’ determination not to choke off a recovery, and a possible post-pandemic consumer spending boom spells trouble. What’s more, factors like globalization and cheap labor in China that have kept price growth low for decades are fading.
“It’s a cocktail that could easily spawn a bout of inflation,” said Stephen Miller, advisor at GSFM, a unit of Canada’s CI Financial Group., and a 30-year bond market veteran. “I’m a bit nervous.”
Skeptics counter that workers have little bargaining power to push up wages (historically a key driver of inflationary episodes) in an era of high unemployment and low unionization. They argue that predictions after the 2008 financial crisis that easy monetary policy would herald the return of inflation fell flat.
For the economy as a whole, not all inflation is bad. In a world awash with debt, some inflation would help ease the real burden.
But for some investors, especially those who remember the corrosive impact of higher inflation in the 1980s, even hearing the debate emerge is enough to jangle the nerves. Inflation chips away at the real value of savings and investments, meaning you need higher returns for your money to keep the same purchasing power.
Here’s What You Can Do To Shield Your Portfolio From The Risk:
Advocates of Bitcoin tout its potential as an inflation hedge due to its inbuilt scarcity — supply is capped at 21 million coins.
Yet skeptics argue something also needs inbuilt value and desirability, not just a limited supply, to be a genuine inflation hedge.
It’s a debate that’s set to continue but the advice from financial professionals is clear: Proceed with extreme caution. The U.K.’s financial watchdog warned consumers investing in cryptocurrencies should be prepared to lose all their money.
The Golden Option
Buying gold is just one of the available options if talk of rising prices has you worried.
You might think gold is your first stop as a hedge against inflation, but it’s not quite so straightforward.
While the precious metal has a track record of keeping its value over the very long term — researchers once estimated that an ounce of gold would have bought the same number of loaves in Babylon over 2,500 years ago as in modern times — in the shorter term it fluctuates like any traded asset. At the moment, gold is down about 10% from last year’s all-time high.
While advisors say gold can be a sensible part of a balanced portfolio in small proportions, they caution against going in too hard. Unlike equities, you don’t earn returns from holding it. And if you buy the physical metal, there are holding costs to consider.
“Even historically, gold and inflation have been uncorrelated for very long periods, for example from 1983 through 1990,” said Guy LeBas, chief fixed income strategist at wealth manger Janney Montgomery Scott. “In the longer term, there is likely some inflation hedge aspect to gold, but there are better inflation hedges elsewhere in the financial system.”
Put Cash to Work
The standard personal-finance rule of thumb is to have three to six months of expenses immediately accessible in cash as an emergency fund. Once you have that (or a higher figure if you believe your position is more vulnerable than average), experts advise looking at alternatives, particularly with interest rates at rock-bottom levels.
“We see a major risk for bank deposits, especially in Asian economies where a large segment of the population has a strong savings mindset and would rather have a large proportion of wealth sitting idle instead of placing it in investment portfolios,” said Dhruv Arora, founder of Singaporean digital wealth manager Syfe. “In today’s environment, investing is a necessity to help retail investors hedge against rising inflation.”
If you are are holding cash because you plan on making a big purchase in the next few years and need certainty, advisers recommend looking for ways to make that money work for you. For example, banks in countries such as the U.K. and Australia offer mortgage offset accounts, where the balance in an account linked to your mortgage is netted off against your loan total, saving you interest.
Term deposit accounts, which require you not to withdraw your money for a set period, also offer slightly higher rates than those that give you instant access.
Economic Growth Exposure
Normally, conventional economic theory holds that inflation occurs when growth is increasing (the stagflation situation of the 1970s when high inflation paired with a recession was an exception). So it would make sense to increase exposure to investments that would benefit during a period of economic expansion.
“There is a tailwind for assets exposed to economic activity,” Leon Goldfeld, portfolio manager with JPMorgan Asset Management multi-asset solutions team said. “You want to have exposure to growth. You want to have diversification as a way of managing risk.”
So companies that can either earn more money in times of growth or have the capacity to raise their prices ahead of cost increases are considered inflation hedges.
Thomas Poullaouec, head of multi-asset solutions Asia-Pacific with T. Rowe Price, says that sectors producing goods included in consumer price inflation baskets are particularly useful. “For example, natural-resources stocks, materials should be beneficiaries of higher commodity prices,” he said.
Another popular option for those seeking protection from rising prices are inflation-linked bonds. These are primarily issued by governments in an effort to keep sovereign borrowing costs low.
Their outstanding principal and interest rates are adjusted in line with inflation. This means they gain value when inflation is rising.
But if inflation stays low, you can lose ground by holding them if regular bond yields increase. They’ve also become more expensive as expectations for increasing inflation have solidified.
As such, their main attraction is for investors who think the risks of inflation are higher than the market is currently pricing in.
Kellie Wood, fixed income fund manager at Schroders Plc in Sydney, says she’s been increasing her portfolio’s exposure to inflation-linked bonds while reducing holdings of nominal bonds partly because she believes that central banks will be willing to tolerate far more inflation that they would have historically. “They’ll need to see the white of its eyes before they tighten,” she said.
Investors looking for an inflation hedge by way of physical assets — one traditional buffer against increasing prices — might take a cue from the upper crust.
“Aristocrats in Europe have long known that you buy land and watch your wealth go up,” said real-estate specialist Chris Bedingfield, portfolio manager at Quay Global Investors. “It holds value.”
Bedingfield is not one of those predicting inflation’s imminent return. But for those who do want to get into property, he suggests focusing on locations, whether residential or commercial, close to urban nodes or popular suburbs.
He cautions, though, that investors should beware of the hype surrounding certain sectors. “The e-commerce boom is real, but a lot of people are overpaying,” he said.
Overall the classic advice still holds true.
“It’s building a diverse portfolio that’s the key,” Alex Shields, an advisor at London-based independent financial planning firm The Private Office said. “I certainly wouldn’t be investing in a single area just to get the inflation protection. ”
Chartists See Scope For S&P 500 To Extend Reflation-Driven Rally
Investors anticipating more stock gains amid the recovery from the pandemic may find support in technical patterns that strategists view as positive for the S&P 500 index.
Technical analysts from JPMorgan Chase & Co. to Evercore ISI are sticking with bullish outlooks for the gauge this year. The index has jumped about 75% from March’s low — a climb that for others raises doubts about the scope for a further substantial advance in 2021. JPMorgan sees the next chart resistance at 4,041 — at what it terms the March bull channel mid line — and then another point at 4,074. The gauge closed at 3,910 on Wednesday.
“Bigger picture, look for bullish trend dynamics to dominate in 2021,” Jason Hunter and Alix Tepper Floman, technical strategists at JPMorgan, wrote in a note. “Even if the market stalls and pulls back over the near term, we do not see a price pattern or other technical indications that suggest the broader rally structure is at risk for a lasting or material reversal.”
The so-called reflation trade aiming to ride the expected economic recovery from the health crisis remains the dominant market theme. At the same time, the prospect of faster inflation and higher bond yields is vexing investors who view such a mix as risky for richly valued stock markets.
Evercore’s Rich Ross wrote in a note Tuesday that chart patterns suggest the U.S. gauge remains on course for 4,050 this quarter, which would be an advance of about 3.5% from current levels. Strategists at Piper Sandler have a year-end target of 4,225, and say the technical setup remains constructive as the S&P 500 continues to generate new highs.
There are some suggestions of a loss of intraday momentum that’s worth noting after a “strong” rally month-to-date, said Katie Stockton, founder of Fairlead Strategies LLC. She pointed to Wednesday’s so-called outside down day, which occurs when a day’s high-low range encompasses a previous day’s range and there is a lower close.
However, “long-term momentum is still to the upside,” she said.
Platinum Jumps On Inflation Concerns, Propelled By Broader Rally
The precious metal is trading at its highest level in six years; prices have more than doubled since hitting a low last March
Platinum prices have neared their highest level in six years, driven by concerns about inflation and a sweeping rally in financial markets that has powered assets from stocks to oil and bitcoin higher.
Most actively traded platinum futures have risen about 17% in 2021 to $1,259 a troy ounce, outpacing most other precious metals. Since their nadir in March last year, platinum prices have more than doubled.
Money managers have started pouring funds into platinum, in part because the metal is seen as a store of value at a time when investors expect government spending to lift inflation. Precious metals are often viewed as a hedge against rising consumer prices. After a run-up in the price of gold last year, some investors have turned to platinum as a cheaper alternative.
“It’s a well-kicked dog that’s getting up,” said R. Michael Jones, chief executive of Platinum Group Metals Ltd., which is developing a palladium, rhodium and platinum mine in South Africa.
Platinum’s comeback initially kicked off with a rebound in industrial consumption of precious metals. It has now been caught up in a broader surge across asset classes, powered by investors who are piling into rising markets in the expectation of further gains.
This upswing, which has come to be known as the “everything rally,” has been fueled by low interest rates and forecasts for a global economic rebound, and prompted concerns that there may be a jarring decline at some point. There are concerns that assets such as platinum and bitcoin are vulnerable to sudden drops when sentiment shifts, but no one knows when a pullback might occur.
Platinum remains cheaper than gold—which fetches $1,823 a troy ounce—as well as palladium and rhodium. That has increased its allure for investors looking to precious metals as a form of insurance against rising prices in the broader economy.
Inflation is well below the 2% pace the Federal Reserve is aiming for. But a measure of how fast bond investors expect prices to rise, known as the 10-year break-even rate, has climbed on the prospect of a $1.9 trillion stimulus plan.
The price of gold, which is also widely seen as a hedge against inflation, has fallen about 4% this year. It surged 24% in 2020, its biggest advance in a decade. The metal, which attracts investor attention when interÌest rates fall, has lost momentum due to a rise in government bond yields and a decline in political uncertainty following the presidential election.
There are some telling signs that the demand from money managers for futures and exchange-traded funds tied to platinum has been strong. Among speculative investors, bullish positions in platinum futures outnumber bearish positions by the biggest margin since last February, Commodity Futures Trading Commission data show.
ETFs backed by platinum owned 3.9 million troy ounces of the metal at the end of January, up from 3.4 million a year earlier, according to the World Platinum Investment Council, an industry group.
“We have seen investors who have owned gold for years recently moving into platinum for the first time,” said Trevor Raymond, research director at the group. Some moved into the market when gold prices rose to record highs last summer, he added.
For platinum, the rally marks quite a turnaround. The market has languished due to a slowdown in sales of diesel-powered cars following the 2015 Volkswagen AG emissions scandal.
One of platinum’s main uses is in catalytic converters that help to strip pollutants from autos that run on diesel. Another precious metal, palladium, is favored for gasoline engines. Demand for both metals could suffer if the adoption of electric vehicles, which harness different materials including cobalt and lithium, gathers speed.
Investors are also betting that platinum will be in high demand if hydrogen-fuel technology becomes widespread, even if that is some years away.
“It looks like it’s the start of a supercycle for metals in general, and especially for green metals,” said Harry Barr, chairman and chief executive of New Age Metals Inc., which is developing a platinum-group metals project in Ontario, Canada.
Giving prices an extra boost, sales of platinum to car makers and sectors such as the glass industry have picked up in recent months. That has lifted demand at a time when disruption at South African mines and processing facilities, including a series of outages at an Anglo American Platinum Ltd. plant, has curtailed production.
Unlike palladium and rhodium, there is no shortage of platinum. Without demand from investors, the market would have been in a surplus last year, according to Emma Townshend, an executive for corporate affairs at Impala Platinum Holdings Ltd. , a South African miner. Although there is some tightness in the market for platinum ingots sought by investors and jewelers, platinum sponge that is used for industrial purposes is abundant, she said.
Some investors say platinum prices are likely to run out of steam if money managers stop plowing money into the market.
U.S. Interest Rates Are Rising..
Rising U.S. interest rates can be bad news for emerging markets, as capital flees to improving returns in the world’s biggest market. In 2013, then-Federal Reserve chairman Ben Bernanke started the so-called Taper Tantrum by merely suggesting he might dial back quantitative easing.
Emerging market stocks dropped 15% in a month. A real Fed tightening cycle in 2018 coincided with an 8% loss for emerging market equities that year.
Treasury yields have climbed a quarter of a percentage point since Jan. 1, driven by renewed fears of inflation. But no new tantrum has come yet. The iShares MSCI Emerging Markets exchange-traded fund (ticker: EEM) has gained 12% year-to-date, trouncing a 4% advance in the S&P 500.
Emerging-market assets “are still fairly well behaved because U.S. rates are rising for the ‘right’ reasons,” says Alejo Czerwonko, chief investment officer for Americas emerging markets at UBS Global Wealth Management. That is, a bit of healthy reflation in the air as vaccines and fiscal stimulus balm the wounds of the pandemic.
The current 10-year Treasury yield around 1.2% would still have been near an all-time low pre-Covid 19, notes Eric Baurmeister, senior portfolio manager for emerging markets debt at Morgan Stanley Investment Management. Alarm about rising prices looks premature with 10 million Americans still out of work. “We’re just not up to inflation yet, which is a nice environment for EM,” he says.
Emerging markets themselves are in better shape to withstand some centripetal force than in 2013, adds Arthur Budaghyan, chief emerging markets strategist at BCA Research. “Then you had large current account deficits and overvalued currencies across EM,” he says. “The vulnerabilities now are much less.”
This time is different than 2018 too, says Marko Papic, chief strategist at the Clocktower Group. Fed chairman Jerome Powell, who hiked rates a full percentage point that year, has turned ultra-dove during the pandemic even as Washington cranks unprecedented spending. That means the Fed could trail inflation, when it comes, depressing effective returns from U.S. bonds. “Real yields will go down faster in the U.S. than anywhere else,” Papic says.
A more substantive threat to emerging markets this year may come from China, which is tapping its policy brakes while the U.S. floors the gas pedal. With coronavirus fading, Beijing will return to deleveraging economic engines like the property market and shadow banking, Budaghyan expects.
That’s sound policy but may prove a rude awakening for commodities and industrial stocks that have been soaring on assumed Chinese demand. Especially if Beijing overdoes it a bit. “The real risk is that China makes a policy mistake severe enough to offset $2 trillion in U.S. stimulus,” Papic says.
Another risk that emerging markets increasingly share with developed ones is valuations that price in a vibrant post-pandemic recovery. Bargains have disappeared as less fashionable sectors join a rally that last year focused on Asian tech stocks, says Josh Rubin, an emerging markets portfolio manager at Thornburg Investment Management.
He’s still seeing value in names like Asian insurance companies Ping An (2318. Hong Kong) and AIA Group (1299: Hong Kong), as a way to play the long-term trend toward “financial inclusion,” or China Gas Holdings (384.Hong Kong), which is riding the carbon reduction wave by replacing coal power in rural China. But it’s getting harder. “A 2021 cyclical recovery is pretty well forecast,” Rubin says. “We have to look now into 2022 and beyond.”
Robots Won’t Save Us From An Age Of Inflation
Longer lives mean more old-age nurses, a role that can’t easily be automated. That could change the balance between labor and capital.
Parsing the Reversal
Thanks to everyone who took part in the latest edition of the Bloomberg book club. Click here for the full transcript of the chat I held with Bloomberg colleague Stephanie Flanders, Barclays Plc senior U.S. economist Blerina Uruci and Manoj Pradhan, co-author of The Great Demographic Reversal. Over two hours, we gave as a good a stress test as we could to Pradhan’s argument that demographics are about to lead to an era of rising inflation and interest rates, and falling inequality.
For now, I’d like to direct your attention to two highlights, and one issue that we didn’t have time for.
The Power of Labor
The key argument of those who don’t believe that inflation is due for an upswing is the undeniable fact that a long economic expansion, accompanied by rising employment, failed to put any significant upward pressure on prices. This was the opening exchange, and captures the debate neatly:
Blerina Uruci: The book takes too pessimistic a view on labor force participation and in doing so it misses the lessons learned from the last expansion. In the U.S., the unemployment rate fell steadily with no signs of accelerating inflation. This challenged the notion of a fixed natural rate of unemployment.
Instead, further improvements in the labor market kept bringing discouraged workers and the long-term unemployed into the labor market. As a result, wages did not push inflation higher. The possibility of further gains in female labor force participation is also a reason to be optimistic.
I want to note that during this time the demographics of an aging labor force were already working in the background.
Manoj, at what point in the next expansion do you think we will start to see the demographic effects dominate in labor force trajectory and push up wages?
Manoj Pradhan: This is a good question, but needs to be seen in the broader context of the last expansion, and then the last 30 years.
Employment fell steadily because capex went nowhere. Firms saw labor as a substitute for capital in a world where growth and interest rates were low and labor was abundant. So they raised the return on capital through financial engineering rather than investment (even after a pro-cyclical tax cut in 2018 when the output gap had turned positive).
One of the things that the Fed rightly pointed out was that wage growth wasn’t strong with a tight labor market because productivity hadn’t risen (because capex hadn’t either). We didn’t get to see the finale play out, but I suspect that a labor market that kept tightening would have led to higher wage growth and inflation eventually — as it turned out, the pandemic struck just as the U.S. output gap was turning positive…
We are arguing for the reversal of this abundance of labor. Labor is still cheap in China but the ratio of U.S.-China real wages has come down from 35-times to 5-times over the last 20 years — that is incredible. With global labor supply growth turning south and the globalization in reverse, firms will invest more. That will push productivity higher, though not miraculously, and support higher wage growth.
Stephanie Flanders: What I have most problem with in the book is the assumption that labor bargaining power and wages will rise in line with the more favorable demand and supply dynamics, and inequality will fall.
Economists such as Richard Freeman at Harvard have shown clearly how rising supply of unskilled labor relative to demand was only part of the reason for long-term decline in unskilled wages. Institutional changes — not least the decline of trade unions and the rising share of service sector jobs (dispersed, hard to organize) seem like a much bigger factor.
To reverse that you not only have to see wholesale institutional change but also a reversal in the tendency for technological change and automation to further reduce labor bargaining power, even in countries where the working age population is already falling.
The failure of inflation to show up, on Pradhan’s argument, therefore has a lot to do with the amazing shock to the world economy provided by the arrival of cheap Chinese labor. That allowed Western companies to stop investing in productivity. The argument for inflation now involves enough investment to spur productivity improvements, but not enough to head off price pressures.
The book has been in the works for many years, and was largely completed before the pandemic hit last year. Covid isn’t the Black Death; it doesn’t change demographics on its own. But it has changed the dynamics of inflation:
Blerina Uruci: I think that many of these behavioral changes will be transitory and I would expect “normal” spending and inflationary patterns to return once the virus is under control through a combination of population immunity and better treatment options. The issues will be how much of the supply capacity of the economy would have been destroyed in the meantime.
The more lasting the damage to businesses and the more labor market scarring, the worse the supply side of the economy once we emerge from this recession. That could lead to higher inflation if demand far outpaces production. And I think it also underscores the importance of stimulus right now to preserve the productive capacity of the economy.
Pradhan Argues That The Experience Of The Last Year Mostly Helps His Hypothesis:
Inflation will materialize much faster than we had expected… Government debt has jumped higher, and central banks have switched to quasi-fiscal QE. Having invited more fiscal intervention, it will be much harder for central banks to switch off the taps to fight the fiscal impact on the economy. It is the first clear sign that central banks will be on the back foot, with fiscal policy dominating the economic landscape in the future.
But the fascinating question concerns inter-generational conflict. Broadly, if people vote to cut back on pension benefits, the inflationary effects that Pradhan and Goodhart warn about are far less likely. Will they really do this? Pradhan points out that for all the anger and dissension of the last 12 months, we are still, albeit begrudgingly in many cases, acting to help out the elderly:
The revealed preference, if we can steal that term for politics, has been to shut down the economy despite lower risks to the young from the pandemic, in order to protect the old. It is ethically the right thing to do without a shadow of a doubt in my mind, but it should also serve to illustrate the power that the elderly wield.
I am inclined to agree, although the strength of the anti-Boomer invective means we can’t take this as a given. Young adults have reason to be aggrieved at their economic opportunities, and it is understandable that they will dislike paying more tax to support a more privileged generation. It still strikes me as a real risk that societies will agree on a less generous settlement for the elderly.
Finally, The Pandemic Could Have Some Longer-Term Mitigating Effects On Inflation, Says Pradhan:
Where does the pandemic dent our thesis? We don’t quite know how far two trends will go. First, we don’t know if working from home becomes the norm — we doubt it, but we cannot be absolutely sure. If that is the case, then the spending patterns in the global economy could be upended and difficult to predict…
Second, we don’t know if the pattern of fatalities from the pandemic will affect saving patterns in the immediate future. Most fatalities have occurred for those over 75, and that means a much smaller cohort of the very old for the next few years (if we assume that life expectancy is around 80 in the Western economies).
Robotics And The Very Old
One area we failed to get into, which adds much muscle to the hypothesis, is that life is getting longer, and increasingly ends in dementia. Longer lives spent in retirement put more stress on welfare states. Does this change the dynamics of the contest between labor and capital? There is an argument that it does, as care work is labor-intensive and hard to automate.
A couple of questioners took us deep into the thickets of how to care for the very elderly. One drew attention to a recently published NBER working paper on the effects of adopting robotics on employment in the Japanese long-term care industry. Here is the summary:
In one of the first studies of service sector robotics using establishment-level data, we study the impact of robots on staffing in Japanese nursing homes, using geographic variation in robot subsidies as an instrumental variable. We find that robot adoption increases employment by augmenting the number of care workers and nurses on flexible employment contracts, and decreases difficulty in staff retention.
Robot adoption also reduces the monthly wages of regular nurses, consistent with reduced burden of care. Our findings suggest that the impact of robots may not be detrimental to labor and may remedy challenges posed by rapidly aging populations.
But will robots reach the point where they really can replace carers? It seems hard to imagine for work that requires so much empathy.
And The Next Book…
For next month, I’m suggesting Reminiscences of a Stock Operator by Edwin Lefevre, a classic of investment literature written almost a century ago. It’s a great read, and for those of you who’ve already know it, there’s much to be said for returning to it.
My main reason for picking it now is that it could give everyone some angles on the GameStop saga. It’s been common to say that such things have always happened, while others argue that social media and electronic trading have changed the ground rules in a profound way. A return to the adventures of Jesse Livermore should provide some valuable perspective on whether anything we now see is truly new, and whether regulators really need to do something.
I suggested earlier this week that there was much creativity in copying someone else’s work. That idea wasn’t terribly original. Pablo Picasso himself said: “Good artists copy, great artists steal.” So here are some great examples of modern songs that got changed radically and creatively.
First, try Nirvana’s Smells Like Teen Spirit. This is this the original, the greatest-ever work of grunge. And here is the same song as performed by Paul Anka, and Tori Amos.
Now try an infuriating Eurovision song winner, Poupee De Cire, Poupee De Son, as performed in 1965 by France Gall, and more than 40 years later by Regine Chassagne of Arcade Fire.
Then there’s Van Halen’s Jump. This is the original. And this is how it sounded when Aztec Camera played it.
And now two Tears for Fears songs. This is their breakthrough hit Mad World, in the original, in a pandemic version that lead singer Curt Smith recorded with his daughter last year, and in the cover version by Gary Jules. And then this is their biggest hit Everybody Wants to Rule the World, in the original, and a very different version by Lorde.
Finally, I’ve commented before that I think The Specials’ Maggie’s Farm captures the anger around the early years of Margaret Thatcher better than any other song from an angry era in British music. So perfectly had it been written to attack the ascendant Maggie Thatcher, that I didn’t find out for more than a decade that it had in fact been written by Bob Dylan.
So if there’s a tip arising from this, it might be that there are worse things than copying others, providing you bring something of yourself to it as well, and acknowledge your debts.
High Lumber Prices Indicate Inflation Is Here
Futures have surged over the past three weeks as the pandemic’s hottest commodity continues to be in high demand.
Lumber prices have shot to fresh records, defying the normal winter slowdown in wood-product sales in a sign that the pandemic building boom is bowling into 2021.
Records have been set across species, products and grades, according to pricing service Random Lengths. It has never cost more to buy oriented strand board, known as OSB and used for walls, Southern yellow pine, which is favored for fences and decks, or ponderosa pine, which is popular in cabinetry and interior trim.
Many engineered wood products used in new construction, such as I-joists, are in short supply, and mills are backlogged with orders well into March, the pricing service said. Last week, its Random Lengths Framing Lumber Composite price rose to $966 per thousand board feet, exceeding the $955 high set in September.
Lumber futures have climbed 49% over the past three weeks, to more than twice the price a year earlier. Lumber for March settled Tuesday at $992.40 per thousand board feet, eclipsing a mark set in September as the highest closing price ever.
Many buyers have jostled into contracts for May delivery, which ended Tuesday at $846.50. The cheapest and most distant futures, for lumber in March 2022, start at $700, which is more than the prepandemic record of $639.
“We don’t expect these prices forever, but what we are seeing is a bit of acceptance that maybe going forward the price level may be different than it has been in the past,” said Chris Virostek, finance chief at West Fraser Timber Co. , North America’s largest lumber producer.
Shares of West Fraser, which acquired leading OSB-maker Norbord Inc. earlier this month, have more than quadrupled since stocks bottomed last March when the economy was shut down to slow the spread of Covid-19. The S&P 500 has gained 75% in the same span.
Mills shut down and choked back output at the pandemic’s onset, reasoning that widespread job losses would wipe out what was looking like a promising spring for home-building. They were wrong.
Stuck-at-home Americans undertook home-improvement projects. Builders faced a stampede to the suburbs, brought on by record-low mortgage rates and people looking for more living space. New York City’s bars and restaurants built outdoor seating so that they could stay in business. Lumber prices shot to new heights.
West Fraser and rivals such as Weyerhaeuser Co. and Interfor Corp. haven’t caught up, despite ramping mills back up to capacity.
In autumn, prices dropped on another erroneous assumption: that building season was winding down. Prices rose anew in November as home builders hammered through mild weather.
Housing starts as well as building permits for private-owned residential units rose in December to their highest levels since 2006, when the bottom was falling out of a yearslong housing boom.
Now, a severe cold snap that settled over much of the continent is disrupting lumber deliveries from Canada while dealers and retailers are stocking up for spring. Strong wood prices in Europe have prevented a flood of imports from dousing the domestic price rally.
Housing affordability is the primary threat to the lumber rally, Weyerhaeuser Chief Executive Devin Stockfish told investors recently.
Home prices are on their fastest climb since the run-up to the housing crash 15 years ago. The frenzy has helped builders protect their profit margins by raising prices on everything from mobile homes to McMansions.
“This is a disruptive and difficult process for the plants, dealers and ultimate home buyers,” said William Boor, chief executive of Cavco Industries Inc., a Phoenix firm that builds modular homes. “So far we’ve been able to keep up.”
The average price of the 7,056 houses that PulteGroup Inc. sold in the fourth quarter was $462,000, up 7% over the year-earlier period, and the builder’s executives say prices are headed higher because of lumber costs.
AvalonBay Communities Inc. said that it has $750 million worth of new apartments on the drawing board. Whether the suburban developer starts all of them depends on lumber costs.
“If lumber pricing doesn’t adjust back to where we would expect it to, some of those starts may be in question,” said Matthew Birenbaum, AvalonBay’s investment chief.
On another front—the shelves of Lowe’s and Home Depot —soaring home prices are supporting lumber’s lofty prices. Rising property values tend to encourage homeowners to undertake renovations. The added home equity can be borrowed against to pay for patios and new kitchens.
U.S. homeowners with mortgages collectively gained about $1 trillion in home equity in the 12 months that ended Sept. 30, according to real-estate data firm CoreLogic Inc.
“Household balance sheets are pretty spectacular right now, and there’s some disposable income that isn’t going into cruises and holidays,” said Bart Bender, Interfor’s senior vice president of sales and marketing. “Yeah, lumber costs a little bit more, but there certainly seems to be a number of people that are pretty focused on improving their homes.”
Import Prices Jump 1.4% In January In Another Sign Of Rising U.S. Inflation
Inflation is returning to pre-pandemic levels.
The numbers: The cost of imported goods jumped 1.4% in January and posted the biggest increase in eight years, adding to mounting evidence that U.S. inflation is returning to levels seen before the coronavirus pandemic began and could go even higher.
What Happened: The increase in the import price index last month was the largest since March 2012, the government said Thursday. While higher oil prices were a big contributor, the cost of most imported goods rose.
Big back-to-back monthly increases pushed the rate of import inflation over the past 12 months to 0.9% in January — the first positive reading in a year. Import prices had fallen sharply early in the pandemic.
If fuel is excluded, import prices moved up a somewhat smaller 0.8% last month. Over the past year import prices minus fuel have risen 2.5%.
U.S. export prices rose 1.3% in January.
The Big Picture: The increase in import prices parallels a rise in inflation domestically. Wholesale and consumer prices have both risen sharply from pandemic lows last summer.
The rate of inflation, as measured by the consumer price index, is likely to reach 2% and perhaps even go higher after the coronavirus fades and the economy returns to normal.
Yet inflation was quite low before the pandemic and had been for years. Federal Reserve Chairman Jerome Powell has repeatedly said he expects an increase in inflation to be temporary.
U.S. Price Pressures Percolate With Surging Sales, Input Costs
The U.S. economy is starting to display pockets of price pressures, further stoking the debate among economists and market participants over the future path of inflation.
Among reports Wednesday, retail sales powered ahead with the strongest advance in seven months, topping all estimates and indicating hearty consumer demand at the start of the year.
Meanwhile, a measure of producer prices surged last month by the most in records dating back to 2009, while a private survey of homebuilders showed growing concern about soaring costs of building materials after a robust year for home sales.
While inflation gauges are expected to pick up steam this year, most notably in the second quarter, many economists — including those at the Federal Reserve — anticipate that annual price gains exceeding the central bank’s 2% target will prove temporary amid still-high unemployment.
Yet recent economic data and expectations of a potential $1.9 trillion in additional fiscal stimulus present upside risks to inflation expectations.
For instance, the health-care services component of the producer-price index, which feeds directly into the core personal consumption expenditures price index tracked by the Fed, surged in January. That introduces “upside risks to the Fed’s current forecast for core inflation,” said Brett Ryan, senior U.S. economist at Deutsche Bank AG.
If sustained, the Fed may reach its inflation goal sooner than anticipated, “potentially bringing forward the timing of tightening,” he said.
The Labor Department’s PPI report also showed the cost of lumber and other construction materials were up 10.4% from January of last year, the most in records. Softwood lumber alone has surged 73%. Price pressures have also developed within manufacturing, where materials costs rose in January by the most since 2018.
On Capitol Hill, Democrats are pressing forward on President Joe Biden’s $1.9 trillion relief plan. Many Republicans say the package is too big, and even Lawrence Summers, who served as Treasury secretary under President Bill Clinton and as a senior economic adviser to Barack Obama, has cautioned a package of that size could spur an inflationary outbreak.
The impact of the relief package passed in December was evident in the 5.3% jump in retail sales, as $600 stimulus payments lined the pockets of consumers. Many Americans, however, are saving rather than spending the latest relief checks, potential tinder for a resurgence in demand later this year for services that have been particularly hard hit by the pandemic.
But Fed Chair Jerome Powell has pushed back against the idea that the economy may overheat with additional stimulus, noting in a recent speech that it could take “many years” to overcome scars from long-term unemployment. Even when the jobless rate was at 3.5% a year ago, signs of inflation were scarce.
Should inflation remain broadly tame, widespread vaccinations should allow for a pickup in activities such as travel and help stabilize prices for hotel stays and airfares. The degree to which pent-up demand may drive inflation metrics higher is unclear.
For their part, Fed officials at the January policy meeting “stressed the importance of distinguishing between such one-time changes in relative prices and changes in the underlying trend for inflation,” according to minutes released Wednesday. Such moves “could temporarily raise measured inflation but would be unlikely to have a lasting effect.”
So-called base effects will influence annual changes in inflation. For several months beginning in March, the price indexes will be compared with the same periods a year ago when inflation slowed considerably as the nation shut down to try to contain the coronavirus.
Boston Fed President Eric Rosengren said Wednesday he wouldn’t be surprised to see higher inflation prints in the near term — with some prices moving up and statistical comparisons to the low inflation figures last year — but he also doesn’t expect to see sustained 2% inflation for the next two years as long as unemployment remains high.
But Kansas City Fed President Esther George said earlier this week that price pressures could build as people return to work. Whether there is “broad-based, persistent pressure on prices that requires the Federal Reserve” to change its policy stance will be “among the core of our deliberations over the coming years,” she said.
Fed Officials Saw Easy-Money Policies Remaining In Place
Minutes of policy meeting in January show expectation of economic pickup but also persistent pandemic risks.
Federal Reserve officials agreed at their most recent policy meeting that they would need to hold interest rates very low and continue central bank bond purchases to help spur the economy’s recovery from the effects of the coronavirus pandemic.
Most of them thought that the $900 billion federal stimulus package approved in December, the likelihood of more fiscal support and continued distribution of Covid-19 vaccines “would lead to a sizable boost in economic activity” this year, according to minutes of the Fed’s Jan. 26-27 meeting.
Still, they noted “the pandemic continued to pose considerable risks to the economic outlook” and they believed that maintaining their current policies “was essential to foster further economic recovery,” the minutes, which were released Wednesday, said.
Officials at the meeting “agreed that the economy remained far from the [Fed’s] longer-run goals and that the path ahead remained highly uncertain,” the minutes said.
Economic reports released since the meeting show the recovery picked up in the new year as consumers used stimulus checks to boost retail spending, manufacturers continued to increase output and employers resumed hiring.
The latest positive signs came on Wednesday when the government said retail sales, a measure of purchases at stores, at restaurants and online, jumped a seasonally adjusted 5.3% in January from a month earlier, and manufacturing output neared pre-pandemic levels.
Fed officials unanimously agreed at the January meeting to hold overnight interest rates near zero, where they’ve been set since March of last year. Officials also elected to continue increasing the Fed’s holdings of Treasury bonds and mortgage-backed securities by at least $80 billion and $40 billion, respectively, per month.
The Fed plans to keep interest rates on hold until its goals of lower unemployment and 2% inflation are achieved. And it plans to continue the current pace of asset purchases “until substantial further progress” has been made toward those goals, the minutes said.
While officials believe those policies have helped the economy, they also tend to drive investors into riskier assets, which can fuel financial bubbles.
A quarterly financial-stability review by Fed staff economists characterized the “vulnerabilities of the U.S. financial system as notable,” with asset valuations seen as elevated, particularly in corporate bonds, according to the minutes.
That reflected more concern than expressed in the staff’s previous assessment, in November, which characterized asset valuations as moderate.
A number of Fed policy makers at the meeting took note of rising equity and corporate-bond valuations, the minutes said. But Chairman Jerome Powell has played down such risks, saying that the Fed’s main priority should be to address the economic distress caused by the pandemic.
“I would say that financial stability vulnerabilities overall are moderate,” he said in a press conference after the January meeting.
Fed’s Yield-Curve Control Isn’t For Taming Long Bonds
As Treasury yields surge, a reminder of what the central bank has left in its toolkit.
Benchmark 10- and 30-year U.S. Treasury yields soared to 12-month highs on Tuesday in a selloff steep enough to make seemingly invincible stock indexes shudder. Like clockwork, market chatter started up: What will the Federal Reserve do to stop this move? Will it institute yield-curve control?
Take a deep breath. Now, to bring up yield-curve control misunderstands how Fed officials, notably Vice Chair Richard Clarida and Governor Lael Brainard, have said they envision carrying out the policy, which remains deep within the central bank’s toolkit. Simply put, yield-curve control has never been about squashing longer-term yields, like those on 10-year notes or 30-year bonds. Instead, it’s a way to make sure bond traders don’t try to strong-arm the Fed into raising short-term interest rates before it’s ready to do so.
Consider these remarks from Brainard in November 2019, which detailed how she’d consider conducting monetary policy at the effective lower bound of interest rates. “There may be advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum — yield-curve caps — in tandem with forward guidance that conditions liftoff from the ELB on employment and inflation outcomes,” she said.
Brainard uses the phrase “short-to-medium” twice more in that speech. Given that the Fed’s “dot plot” projections extend about three years, followed by a “longer-term” dot, it stands to reason that the caps likely wouldn’t go beyond three to five years.
As for that last part on forward guidance, remember the Fed has already committed to such a policy. In September, the central bank pledged to keep the fed funds rate unchanged in a range of 0% to 0.25% “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” Yield-curve control would come into play only if bond traders anticipated the economy would meet those thresholds far more quickly than the Fed did.
So far, that hasn’t happened, even with the swift moves at the long end. Two-year Treasuries still yield just 0.12%. Three-year Treasuries are at 0.23%. Even five-year Treasuries, which reached the highest since March 20 on Tuesday, are a mere 0.57%. Before 2020, the record-low for five-year yields was 0.5345% in July 2012. Suffice it to say, the bond market is not pricing in much in the way of Fed rate increases in the coming years by any measure.
What bond traders are pricing in, rather, is the combination of accommodative monetary policy and supportive fiscal policy successfully boosting economic growth and inflation. This is by design. A steepening yield curve, in fact, should be music to Chair Jerome Powell’s ears, not cause for alarm.
The curve from 5 to 30 years is 152 basis points, the steepest since October 2015, while the gap between 2-year and 10-year yields is 119 basis points, the most since March 2017. Real inflation-adjusted yields are on the rise across the curve as well.
Still unconvinced the Fed won’t move to bend the longest-dated Treasuries to its will? After all, in Brainard’s speech, she did argue that “yield-curve ceilings would transmit additional accommodation through the longer rates that are relevant for households and businesses.” How does that square with benchmark U.S. yields marching higher?
Well, consider one long rate relevant to households: The Freddie Mac 30-year mortgage rate. It’s currently 2.73%, not far from the record low 2.65% set on Jan. 7. The 10-year Treasury yield, meanwhile, has jumped about 40 basis points since the beginning of the year to 1.31%.
The difference between the two rates is certainly lower than it was in 2020, but it’s roughly in line with the average spread over the past decade. It’s certainly conceivable that mortgage rates could remain near all-time lows even as benchmark Treasury yields grind higher.
Meanwhile, the average investment-grade company pays just 92 basis points over Treasuries to borrow, approaching the record low 76 basis points from 2005. If longer-term yields keep rising, that means investors see a brighter economic outlook, which should bolster the creditworthiness of corporate America and serve to compress credit spreads further, potentially offsetting the rise in underlying yields.
To be clear, the Fed is certainly showing no eagerness to institute yield-curve control. Minutes of the Federal Open Market Committee’s June meeting revealed the staff discussed “in light of the foreign and historical experience with approaches that cap or target interest rates along the yield curve, whether such approaches could be used to support forward guidance and complement asset purchase programs.”
During the conversation, “nearly all participants indicated that they had many questions regarding the costs and benefits of such an approach.” The fact that explicit references to curve control have disappeared in more recent Fed minutes suggests policy makers found the costs too steep for now.
Perhaps the Fed will revisit yield-curve control someday. But it won’t be because of rising long-end Treasury rates. As long as the yield curve is steepening for the right reasons — expectations for stronger growth and higher inflation, combined with years of easy monetary policy — Powell and his colleagues will be just fine watching from the sidelines.
‘Go Big’ Reflation Bet Sees Virus Victory Assured
A sharp increase in economic activity is now the base case for markets.
Stocks Beat Bonds
It looks like I’m off the hook. Back on Oct. 8, 2018, I started a new chapter in life and reported to work at Bloomberg for the first time. That was also the day when U.S. stocks recorded an all-time high relative to bonds, and began a descent that would become an all-out collapse with the onset of the pandemic 17 months later.
These events were, of course, completely unrelated. But I’m still a little relieved that stocks (as proxied by the popular SPY exchange-traded fund) have in the last few days eclipsed their October 2018 high relative to long bonds (as proxied by the TLT exchange-traded fund of Treasury bonds with maturities of 20 years or longer). In a classic signal of optimism about future growth, stocks have now beaten bonds for my Bloomberg career.
Other measures of the bond market confirm a reflationary call, with the yield curve steepening. Meanwhile, commodities are also signaling reflation. The following chart shows the performance since the beginning of 2016 of the Refinitiv/CoreCommodirty CRE index which aggregates a number of sectors, and Bloomberg’s own commodity index. The former is sometimes held to underweight energy, while Bloomberg’s is sometimes said to overweight it, but both measures are in agreement at present.
Even Japan, the country whose deflation provided a cautionary tale to the rest of the world, is giving out the same signal. The following chart shows 10-year government bond yields since the beginning of 2016, when the Bank of Japan embarked on yield curve control. Yields are positive again, and their highest in more than two years.
Japanese stocks have joined the party. The Nikkei 225, the best-known measure of the stock market, is above 30,000 for the first time in three decades. It first dropped below 30,000 in August 1990, on the news that Saddam Hussein’s Iraq had invaded Kuwait.
Much history has happened since then. (And incidentally, it started its fall, after peaking on the last trading day of 1989, on my first day at work at the Financial Times; again, I’m sure this is coincidental.)
What is intriguing about all of this is that markets are definitely doing what they are supposed to do, and moving to discount events before they happen. “Surprise” numbers have come down to earth recently, as forecasters have been disappointed by the way developed economies dealt with the resurgence of the pandemic over the winter. The widely followed “nowcast” of U.S. GDP kept by the Atlanta Fed suggests the economy is back to only inching forward
So why is so much being taken for granted? The answers boil down to two factors. First, economic policy. The phrase “go big,” as uttered by newly installed U.S. Treasury Secretary Janet Yellen, fairly screams out from the front of research notes. The return of Mario Draghi to a key position in Europe only strengthens the conviction that policymakers are determined to err on the side of too much action rather than too little.
Plainly, the risk is that they will provoke inflation (as former Bank of England Governor Mervyn King argues for Bloomberg Opinion), but they don’t want to be cowed by a specter that has remained unseen in decades. (This piece by Binyamin Appelbaum for the New York Times makes that case well).
Second, there is the coronavirus itself. A huge market bet is under way that the pandemic is at last coming under control, with vaccines the critical weapon. The case is solid, although carrying a worrying amount of weight, and can be illustrated with some charts. First, Variant Perception shows that U.S. Covid cases and impacts are falling, while hospital admissions have stopped rising virtually everywhere in the country
In Europe, off to a much slower start in vaccinating, the rate of positive tests is falling. This is happening across the great majority of developed world nations.
News on the most specific areas of risk, which would require the greatest dents in economic activity, is also good. This chart, from Whitney Tilson of Empire Financial Research, shows the number of confirmed cases and deaths in U.S. nursing homes. It certainly looks as though the vaccine is having an impact already.
Data from the U.K. are arguably even more encouraging. Britain was the first developed nation to be hit by a significant variant of the virus, which forced the government into a new and heavier lockdown policy — but it has also been very successful in rolling out the vaccine.
The following chart, from London’s Longview Economics, shows the trend in the number of deaths from three age groups, up to the peak in January. After an appalling spike as the mutation took hold, the fall-off has been impressive, and must raise hope (if not proof) that vaccines will be enough to counter further variants.
But, critically, while the war on the virus looks as though it might at last be reaching a final and victorious stage, levels of economic activity remain almost as subdued as ever. This is true across many countries. Here are Google mobility data for the U.S., as cited by Longview Economics.
And here are the same data for Germany.
Plenty of other data will confirm that our behavior, whether voluntary or forced upon us by governments, remains restrained. The potential for a sharp increase in economic activity, bringing with it the kind of jump in growth that bond markets should hate, is very real. In the last few weeks, the market has adopted it as a base case.
There are plenty of risks. For a start, the vaccine rollout could be botched, or a virus strain could emerge that is impervious to vaccines. The risk of overheating amid huge amounts of liquidity is evident. And central banks might yet take fright at the first sight of inflation.
Headline numbers are bound to look bad for the next few months. But as it stands, the market is telling us that final victory over the virus is in sight, and that this won’t stop the authorities from going big in response, meaning quite an economic boom. It would be nice if they were right.
IHS Markit’s U.S. Price Gauges Reach Highest In Records To 2009
Measures of prices paid and charged by U.S. businesses jumped in February to the highest levels in records back to 2009, fanning concerns of accelerating inflation.
While higher raw materials costs along with supply-chain and transportation challenges drove up prices, demand strengthened at services providers and remained robust at manufacturers, according to IHS Markit data issued Friday.
The group’s flash composite index of business activity edged up to 58.8, the highest since 2015, from 58.7 a month earlier. Readings above 50 indicate growth.
“The data add to signs that the economy is enjoying a strong opening quarter to 2021, buoyed by additional stimulus and the partial reopening of the economy as virus related restrictions were eased on average across the country,” Chris Williamson, chief business economist at IHS Markit, said in a statement.
“A concern is that firms costs have surged higher, driving selling prices for goods and services up at a survey record pace and hinting at a further increase in inflation,” Williamson said.
The IHS Markit’s flash services PMI also rose to the highest level since March 2015 as virus-related restrictions began to ease. The group’s manufacturing index, however, declined as supply shortages led to the longest delivery times in records back to 2007.
IMF Sees Limited Inflation Risk From Biden’s $1.9 Trillion Plan
The International Monetary Fund is weighing in on the debate over U.S. President Joe Biden’s $1.9 trillion stimulus proposal, saying that it sees only limited inflation risk, a rebuttal to some critics who worry about the American economy overheating.
The past four decades of experience suggest that any surge in U.S. price pressures is unlikely to push inflation persistently above the Federal Reserve’s 2% inflation target, IMF chief economist Gita Gopinath wrote in a blog on Friday.
She noted relative stability in inflation from 2009 to 2019 even as wages rose amid a sharp drop in unemployment, and said that the headline U.S. jobless rate, now 6.3%, understates gaps in employment.
The fund estimates that Biden’s proposed package, equivalent to 9% of gross domestic product, would increase U.S. GDP by a cumulative 5% to 6% over three years, with the Fed’s inflation measure quickening to around 2.25% in 2022.
That would be in line with the Fed’s new policy framework adopted last year, Gopinath said, referring to the central bank’s plan to sometimes allow inflation to run above the 2% target to make up for prior undershoots.
The comments inject the IMF into a debate that has seen prominent economists and market participants raise questions about the impact of the package. Lawrence Summers warned that a stimulus closer to the levels of World War II could spark inflationary pressures “not seen in a generation.”
Treasury Secretary Janet Yellen argues that policy makers have the tools to deal with possible faster inflation, and that the greater danger is doing too little.
IMF Managing Director Kristalina Georgieva earlier this month warned that the U.S. could face “a dangerous wave of bankruptcies and unemployment” if fiscal support isn’t maintained until there’s a durable exit from the health crisis.
Reports this week showed the U.S. economy is starting to display pockets of price pressures. Retail sales advanced the most in seven months, topping all estimates and indicating strong consumer demand at the start of the year.
A gauge of producer prices surged last month by the most in records dating back to 2009, while a private survey of homebuilders showed growing concern about soaring costs of building materials after a robust year for home sales.
Factors that will help keep prices in check range from globalization, which has limited inflation in traded goods, to firms with room to adjust profit margins, Gopinath said. Automation, along with relative declines in the price of capital goods, has largely kept higher wages from being passed through to prices, she said.
Still, public spending should be well-targeted to deliver the same improvement in employment and output while taking on less debt, allowing more room for future spending with a high social return, Gopinath said.
The current crisis also has almost no parallel in history, making the use of past comparisons risky. Pent-up demand once vaccines are deployed could trigger strong recoveries and inflation that defies expectations based on evidence from recent decades, Gopinath said.
Summers Says Fed May Be Forced To Raise Interest Rates Next Year
Former U.S. Treasury Secretary Lawrence Summers warned that the Federal Reserve will likely be pressured into raising interest rates sooner than markets expect, and perhaps as early as next year.
An overheating economy and rising prices could force the Fed’s hand, Summers said in an interview with David Westin for Bloomberg Television’s “Wall Street Week” to be broadcast Friday.
Summers, a top official in the past two Democratic administrations, has emerged as one of the leading critics among Democrat-leaning economists of President Joe Biden’s $1.9 trillion pandemic plan. He’s argued that the measure will pump too much cash into the economy, pushing it past capacity limits and triggering inflation, and called for a focus on longer-term investments instead.
Administration officials have pushed back against the critique, saying the Biden bill aims to provide relief to those in need and won’t overheat an economy still suffering from high unemployment. Fed officials have broadly echoed that view — flagging the risk of delivering too little fiscal support, and signaling they have no intention of tightening monetary policy anytime soon.
That stance shows Fed officials are “not recognizing the era they are headed into,” said Summers, who’s a paid contributor to Bloomberg. He said the central bank will soon face the same challenges that it did in the 1970s, when it failed to get a grip on inflation.
“If the Fed wants to not fail, they’re going to have to start recognizing the reality of those challenges,” Summers said. “That’s going to mean a significant change in their tone.”
Summers said the Biden proposals will channel too much money onto household balance sheets, such as stimulus checks that will likely be saved, instead of investing to expand the economy’s productive capacity. “I can’t imagine a lower-priority use of federal resources than improving consumer balance sheets,” he said.
The Biden administration plans to move on to legislation that will boost investment in infrastructure and clean energy after the coronavirus relief package is passed.
Constant Money-Printing Finally Results In Rapid Increase In Commodity Prices
Commodities markets are booming. Oil is up about 30% this year, copper just hit a nine-year high and grains markets are experiencing shortages.
But there’s a subtler factor helping propel the value of the world’s raw materials ever higher: yield.
At a time when interest rates are feeble and bond yields remain historically depressed, rolling positions along the commodities futures curve offers passive investors tempting returns. It’s a proposition that has gotten some of the biggest research departments on Wall Street, from Goldman Sachs Group Inc. to Citigroup Inc. talking up commodities returns this year.
The logic is simple. When markets are tight, nearby futures contracts are more expensive than later ones. That means investors can buy contracts today, and when they have to roll them to later months, they get the same exposure at a cheaper price. Profiting from these gaps captures what investors call roll yield — it’s a trade that draws speculative money into commodities, driving further price gains.
Over 12 months that process — known as positive carry — currently returns 9% in oil and about 3% in copper, offering a healthy return even before any further price increases. With yields from many of the more conventional asset classes depressed, it’s one of the reasons why money has been flowing into the commodity space.
“If you’re in a positive carry market, it’s really a good thing,” said Greg Sharenow, a portfolio manager focused on energy and commodities at Pacific Investment Management Co. “It could be a really significant driver of returns and a really important component of how an investor performs in the next year.”
Supercharged Commodity Boom: Definitely. Supercycle? Not Exactly
The fundamental reasons behind the rally in commodities markets vary. In oil and copper markets, there’s an expectation that demand will begin to eclipse supply amid the roll-out of vaccines and loosening of movement restrictions, coupled with economic stimulus measures.
Other markets are seeing more particular factors. Sugar, for example, is benefiting from port delays and a shortage of containers to ship the sweetener, as well as smaller crops in some regions.
In the broadest terms, though, one thread links the multibillion dollar markets for raw materials: the desire of investors to profit from a rebound in the global economy and inflation.
“Part of what you’re seeing pushing these markets higher right now is that hedging demand to deal with inflation,” Jeff Currie, head of commodities research at Goldman Sachs said in an interview with Bloomberg Television. “The demand to hedge that risk through commodities is quite high.”
And that’s where the tantalizing yields come into play. In a basket of 20 commodities, net-bullish positions have risen 16% this year alone. They’re up more than sixfold since the middle of last year.
It’s not without risk though. A sharp pullback in prices can outweigh the gains from positive carry, if markets move in the wrong direction.
There may be more inflows to come. Citigroup Inc. says surging demand will see copper prices hit $10,000 a metric ton in the coming months. Last week, Deere & Co. boosted its profit outlook, with the tractor giant seeing the early days of a demand pick-up in the farming economy. Over the last 10 years, when oil yielded this much, prices were at least $10 higher, and sometimes nearer $100 a barrel.
It’s how the cycle continues. As prices rise, so-called backwardation — in which nearer-term contracts are costlier than those for later dates — is steadily amplified. That in turn helps attract new investment, and means prices keep on rising.
“I suspect backwardation can go higher,” Ben Luckock, co-head of oil trading at Trafigura Group said in a Bloomberg TV interview, referring to the crude oil markets. “We are very bullish what the market looks like going forward and that means backwardation is here for the foreseeable future.”
Food Prices Are Soaring Faster Than Inflation And Incomes
As the Covid-19 pandemic wreaks havoc on economic growth, concerns about hunger and malnutrition are rising around the world.
Global food prices are going up, and the timing couldn’t be worse.
In Indonesia, tofu is 30% more expensive than it was in December. In Brazil, the price of local mainstay turtle beans is up 54% compared to last January. In Russia, consumers are paying 61% more for sugar than a year ago.
Emerging markets are feeling the pain of a blistering surge in raw material costs, as commodities from oil to copper and grains are driven higher by expectations for a “roaring 20s” post-pandemic economic recovery as well as ultra-loose monetary policies.
Consumers in the U.S., Canada and Europe won’t be immune either as companies — already under pressure from pandemic-related disruptions and rising transport and packaging costs — run out of ways to absorb the surge.
“People will have to get used to paying more for food,” said Sylvain Charlebois, director of the Agri-Food Analytics Lab at Dalhousie University in Canada. “It’s only going to get worse.”
While never welcome, the coming round of food inflation will be especially tough. As the pandemic wrought havoc on the global economy, it ushered in new concerns about hunger and malnutrition, even in the world’s wealthiest countries.
In the U.K., the Trussell Trust gave out a record 2,600 food parcels a day to children in the first six months of the pandemic. In the U.S., the Covid-19 crisis pushed an additional 13.2 million people into food insecurity, a 35% jump from 2018, according to estimates from Feeding America, the nation’s largest hunger-relief organization.
In the U.S., prices rose close to 3% in the year ending Jan. 2, according to NielsenIQ, roughly double the overall rate of inflation. That small jump adds up, particularly for families already near the edge. The poorest Americans already spend 36% of their income on food, according to the U.S. Department of Agriculture, and mass layoffs in lower-wage work like retail and transportation have increased the strain on household budgets.
Meanwhile, the price of staples like grains, sunflower seeds, soybeans and sugar have soared, pushing global food prices to a fresh six-year high in January. They’re not likely to fall any time soon, thanks to a combination of poor weather, increased demand and virus-mangled global supply chains.
Developed markets tend to be insulated from short-term price spikes, because food is more processed and the food chain is more elaborate. In the process of turning a bushel of corn into a bag of Tostitos, food companies have a lot of room to absorb incremental costs, said David Ubilava, a senior lecturer at the University of Sydney who specializes in agricultural economics. But when costs stay high for a sustained period of time, companies start thinking about how to pass them on.
“We are experiencing inflation right now as is everybody else,” Conagra Brands Inc. Chief Executive Officer Sean Connolly said in an interview. Costs are up for oils, pork and eggs, plus packaging materials like cardboard and steel. The company, parent to more than 70 brands including Birds Eye, Chef Boyardee, and Udi’s Gluten-Free, says raising prices is one of the levers it could pull this year to counter rising costs.
General Mills, the maker of Cheerios, Yoplait and and Blue Buffalo pet food, is also looking at price increases, said Jon Nudi, who leads the North American retail division, at least “in the areas we see significant inflation.” Dave Ciesinski, Chief Executive Officer of Lancaster Colony Corp., which makes the Marzetti brand and others, said they anticipate a sustained period of rising costs.
The company is going to have to figure out how to “justifiably or appropriately pass on these costs,” he told analysts in an earnings call.
Even the cost of white label goods — also known as house brands — is likely to go up, notably in the second half of the year, said Steven Oakland, CEO of Treehouse Foods, which makes products for grocery stores to sell under their own brand names.
“We’re working very closely to decide what can we mitigate,” he said. “What do we need to pass on? What’s the right movement with the consumer?”
The increases might not be immediately obvious to shoppers. Instead of raising the sticker price, retailers may cut back on multi-buy deals or special promotions. Last year, the number of grocery items sold on promotion in the U.S. dropped by 20 percentage points, according to NielsenIQ data, partly because pandemic-driven logistical challenges squeezed supply.
There may also be another round of so-called shrinkflation, where the price stays the same but the product size shrinks. That’s long been a popular tactic in the U.K., where a decade long supermarket price war has kept prices low.
A study by the Office for National Statistics found between Jan. 2012 and June 2017 — a period when food companies faced rising costs, plus a weakening pound — as many as 2,529 products were made smaller, more than four times the number that increased in size. British shoppers took special exception to the shrinking of Mars’ Maltesers by 15% and Birds Eye dropping from 12 to 10 fish fingers in a packet.
“I expect it to be a continued feature of the way that food is sold in the U.K. going forward,” Richard Lim, CEO of consultancy Retail Economics said. “I don’t think we’ll see a stop to this.”
Right now, food prices in the U.K. are flat or declining but Liliana Danila, economist at the British Retail Consortium, says she expects that to change, and it could come as a bit of a shock. A decade-long supermarket price war has accustomed British consumers to the cheapest prices in Europe. “They are maybe a bit more likely to be less prepared than consumers in other places,” Danila said.
Adding to the pressure in the U.K. is the impact of Brexit, which is adding complications and delays to previously frictionless trade. The U.K.’s Food and Drink Federation estimates that red tape and new border checks could add 3 billion pounds ($4.1 billion) in costs per year for food importers.
The food industry in North America has its own expensive challenges. In particular, a shortage of both shipping containers and truck drivers has made it more costly to transport food, and the rising price of oil has raised packaging costs.
In emerging markets, where people typically eat food closer to its natural state and prices change quickly, families are having to confront the issue right now.
“I got smaller piece of tempeh and tofu now, with the same price as last week,” said Rahayu, who goes by one name as many in Indonesia do, a 64-year-old grandmother in West Java province, noting that in recent weeks, the price of chili had more than doubled to 70,000 rupiah ($4.97) per kilogram. “I’m going to need to use less.”
With these pressures building, Russia and Argentina have put price curbs on certain staples and slapped tariffs on exports in an attempt to contain domestic food prices.
In some richer countries, governments are focusing more on self-sufficiency than price controls. France is planning to boost its output of high-protein crops to cut reliance on soybean imports, while Singapore recently became the first country to approve sales of lab-created meat as it pushes to boost its domestic food capacity.
Others are looking to broad stimulus measures. Testifying before the U.S. House Financial Services Committee last week, Federal Reserve Chair Jerome Powell pointed to food insecurity as one example of how the pandemic has strained poorer communities, and as another impetus to get the economy moving again.
“I think we’ve all been struck — how could you not be struck — by the uptake in the food area,” Powell said. “It’s a sign that support is needed and we really need to get the economy recovered as soon as possible.”
The Fed Doesn’t Fear Inflation. Its Critics Have Longer Memories
Milton Friedman saw the great uptick of the 1970s coming, and Larry Summers has similar warnings today. Jerome Powell would do well to listen.
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
It was in a lecture delivered in London in 1970 that Milton Friedman uttered those famous words, the credo of monetarism.
Over the previous five years, inflation in most countries had been on the rise. In the first half of the 1960s, U.S. consumer prices had never gone up by more than 2% in any 12-month period. The average inflation rate from January 1960 until December 1965 had been just 1.3%. But thereafter it moved upward in two jumps, reaching 3.8% in October 1966 and 6.4% in February 1970.
For Friedman, this had been the more or less inevitable consequence of allowing the money supply to grow too rapidly. The monetary aggregate known as M2 (cash in public hands, plus checking and savings accounts, as well as money market funds) grew at an average annual rate of 7% throughout the 1960s. Moreover, as Friedman pointed out in his lecture, the velocity of circulation had not moved in the opposite direction.
What no one knew in 1970, though Friedman certainly suspected it, was that much worse lay ahead. By the end of 1974, U.S. consumer prices were rising at more than 12% a year. The “great inflation” of the 1970s (which was only really great by North American standards) peaked in early 1980 at 14%. Friedman’s London audience had an even rougher ride in store for them. U.K. annual inflation hit 23% in 1975.
That year, as an 11-year-old schoolboy, I wrote a letter to the Glasgow Herald (my first ever publication) that bemoaned the price of shoes, because I could see my mother’s sticker shock each time I needed a new pair. Prices were rising significantly faster than my feet were growing — and that was saying something.
In recent weeks, investors have been acting in ways that suggest they fear a repeat of at least the first part of that history — the 1960s, if not the 1970s. On Thursday, Federal Reserve Chair Jerome Powell made the latest of multiple attempts by Fed officials to reassure markets that they have nothing to fear from a temporary bout of higher inflation as the U.S. economy emerges from the Covid-19 pandemic.
In response, you could almost hear the chants of “always and everywhere a monetary phenomenon.” After all, the latest M2 growth rate (for January) is 25.8% — roughly twice the rate at inflation’s peaks in the 1970s. (Yes, I know velocity is way down.)
The crucial indicator in this debate is inflation expectations. These can be measured in various ways, but one of the best is the so-called breakeven inflation rate, which is derived from five-year Treasury securities and five-year Treasury inflation-indexed Securities, and tells us what market participants expect inflation to be on average in the next five years. Less than a year ago, that expected inflation rate was down to 0.14%. Last Wednesday it was at 2.45%. The last time it was that high was in April 2011.
Another indicator of market anxiety is the steepening of the yield curve (though that could well be capturing growth expectations as well as inflation fears). In the shock of the pandemic, the yield on 10-year Treasuries fell as low as 0.6%. Now it is up to 1.56%. Because the yields of government bonds with shorter maturities have not moved up so much, the widening spread can be seen as a further sign that markets expect inflation.
To some observers, including Fed economists, all this seems like market overreaction. The Fed’s preferred measures of inflation, derived from the price indices of personal consumer expenditures, have consistently undershot the 2% inflation target for most of the period since the global financial crisis. In only 10 months out of the 149 since Lehman Brothers Inc. went bust has core PCE (excluding the volatile costs of energy and food) exceeded 2%.
The latest reading is 1.5%. Indeed, average core inflation has been 1.9% for the past 30 years — since the presidency of George H. W. Bush. In any case, the economy is only just emerging from one of the biggest supply shocks in economic history — the lockdowns and other “non-pharmaceutical interventions” to which we resorted to limit the spread of the SARS-CoV-2.
Looking at the past three decades, you can see why the Fed subscribes to what might be called the Mad Magazine view of inflation: “What, me worry?” Last month, Powell said, “Frankly we welcome slightly higher … inflation. The kind of troubling inflation people like me grew up with seems unlikely in the domestic and global context we’ve been in for some time.”
Since last September, the Fed has pledged to keep its Fed funds rate at near zero and its bond purchases (quantitative easing) going until the labor market has made “significant progress” in recovering from the Covid shock.
In very similar speeches last week, Fed Governor Lael Brainard and Mary Daly, president of the San Francisco Fed, reiterated this commitment. It’s not just that they don’t worry about inflation above 2%. They actively want inflation above 2% because they are now targeting an average rate of 2%.
In making this argument, the Fed folks are telling us that post-pandemic inflation will be so fleeting as to leave expectations essentially unchanged. “A burst of transitory inflation,” in Brainard’s words, “seems more probable than a durable shift above target in the inflation trend and an unmooring of inflation expectations to the upside.”
Those who worry about such an unmooring, argued Daly, are succumbing to “the tug of fear … a memory of high and rising inflation, an inexorable link between unemployment, wages and prices, and a Federal Reserve that once fell behind the policy curve. But the world today is different, and we can’t let those memories, those scars, dictate current and future policy … That was more than three decades ago, and times have changed.”
Now, I plead guilty to having worried about inflation prematurely in the past, something for which I was vehemently (and unfairly) criticized by Paul Krugman and others. Eleven years later, I am not about to repeat that mistake. Yes, the administration of President Donald Trump ran the economy hot with big tax cuts and browbeat the Fed to abandon its planned normalization of monetary policy — and even at 3.5% unemployment, inflation barely moved.
Yes, as Skanda Amarnath and Alex Williams very reasonably argue, the reopening of services such as bars and restaurants will likely push up PCE inflation, but not by much and only temporarily. Only if inflation is sustained and accompanied by equally sustained wage inflation would the Fed need to change its stance.
Yet this entire debate has been turned on its head by the intervention of former Treasury secretary and Harvard University President Lawrence Summers. Back in 2014, it was Summers who resurrected the idea of “secular stagnation,” predicting (correctly, as it proved) that the period after the global financial crisis would be characterized by sluggish economic performance and very low interest rates.
There was therefore some consternation in the world of economics when Summers published a stinging critique of President Joe Biden’s proposed $1.9 trillion fiscal stimulus on Feb. 4.
“There is a chance,” warned Summers, “that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”
At this point, we need to make our first qualification of Friedman’s monetarist credo. Actually, inflation is often and in many places a fiscal phenomenon — or at least, you don’t get inflation without a combination of fiscal and monetary expansion. Summers’s point is that the proposed fiscal stimulus is far larger than the likely output gap, insofar as that can be estimated.
Even before the additional stimulus, Summers wrote, “unemployment is falling, rather than skyrocketing as it was in 2009, and the economy is likely before too long to receive a major boost as Covid-19 comes under control. … Monetary conditions are [also] far looser today than in 2009. … There is likely to be further strengthening of demand as consumers spend down the approximately $1.5 trillion they accumulated last year.”
Although economists working for the Biden administration and Democratic Party operatives shot back, Summers’s argument was endorsed by other big hitters, notably Olivier Blanchard, only recently a proponent of active fiscal policy. Martin Wolf, a rampant Keynesian in the period after the financial crisis, called the stimulus plan “a risky experiment.”
Even investors who don’t share my respect for these academic economists could hear a version of the same argument from two of the great financial market players. “Bonds are not the place to be these days,” wrote Warren Buffett in the latest Berkshire Hathaway report. “My overriding theme is inflation relative to what the policymakers think,” Stan Druckenmiller said in an interview. “Basically the play is inflation. I have a short Treasury position, primarily at the long end.”
Time for a further amendment to Friedman’s credo. Like the equation that encapsulates the quantity theory of money (MV=PQ), the assertion that inflation is always a monetary phenomenon verges on being a tautology. In truth, monetary expansions, like the fiscal deficits with which they are often associated, are the result of policy decisions, which are rooted in decision-makers’ mental models, which originate in some combination of experience and study of history.
The Fed folks are telling us that inflation expectations will stay anchored, even if inflation jumps above 2% for a time. The big beasts of economics and investment may just have longer memories. Both Blanchard (72) and Wolf (74) are old enough to remember the 1960s, and both refer to what happened then with good reason.
Our own time has quite a lot in common with the 1960s, as I argued last June in the first column I wrote for Bloomberg Opinion. True, the Woodstock generation was into free speech, whereas the Wokestock generation wants to cancel it, but there’s the same sense of a generation war. There’s a crazy right, too, as we saw on Jan. 6. It’s just that today the arguments for separating black and white students are made on the crazy left.
The economic similarities are there, too. The economists who served in the John F. Kennedy and Lyndon B. Johnson administrations — such as Walter Heller of the University of Minnesota — had as much faith in the power of fiscal policy as those now serving under Biden.
“Our present choice,” declared Kennedy, “is not between a tax cut and a balanced budget. The choice, rather, is between chronic deficits arising out of a slow rate of economic growth, and temporary deficits stemming from a tax program designed to promote … more rapid economic growth.” The 1964 budget, which cut both individual and corporate tax rates, testified to the dominance of Keynesian ideas at that time.
The only difference is that by today’s standards, the deficits of the 1960s were tiny, peaking at 2.8% of gross domestic product — a figure regarded as so excessive that in 1968 Congress passed the Revenue and Expenditure Control Act, effectively reversing the 1964 tax cuts.
As in our time, the Fed was confident that there was a stable tradeoff to be exploited between inflation and unemployment. As Allan Meltzer showed in his history of the Fed, the easing of monetary policy in 1967 was a grave error, one recognized by Fed Chair William McChesney Martin by the end of that year (“the horse of inflation not only was out of the barn but was already well down the road”).
An important difference was the distorting effect of the Fed’s Regulation Q, which imposed interest rate ceilings on savings accounts in 1965, discouraging saving, boosting consumption, and limiting the effective transmission of monetary policy.
Then, as now, the global financial system revolved around the dollar, to the annoyance of European leaders such as President Charles de Gaulle of France, who complained of the American currency’s “exorbitant privilege.”
The difference was that the dollar was still linked to gold under the Bretton Woods rules of (mostly) fixed exchange rates. Fears that the U.S. might break the link to gold and devalue the dollar — which were fulfilled by Richard Nixon in August 1971 — may have played a part in pushing up inflation expectations.
In a seminal paper first published in 1981, the economist Thomas Sargent argued that “big inflations” ended only when there was “an abrupt change in the continuing government policy, or strategy, for setting deficits now and in the future that is sufficiently binding as to be widely believed.” The corollary of this insight must be that inflations begin with a comparable regime change, but one that is imperceptible rather than abrupt.
Sargent elaborated on this point in his 2008 presidential address to the American Economic Association, in which he argued that policymakers might easily form “incorrect views about events that are rarely observed.”
The situation that we are always in [is] … that our probability models are misspecified. … The possibility [exists] that learning has propelled us to a self-confirming equilibrium in which the government chooses an optimal policy based on a wrong model … Misguided governments [fall into] lack-of-experimentation traps to which self-confirming equilibria confine them.
This nicely encapsulates the mistakes made at the Fed in the 1960s. It might well turn out to describe the mistakes being made at the Fed right now. Thirty years of very low inflation seems like the perfect basis for a wrong model.
There is one important caveat, nevertheless. The biggest difference between our own time and the 1960s is that we are coming out of a pandemic, whereas then the U.S. was sliding deeper into a disastrous war. Economic historians have long been aware that, for most of history, war has been the principal driver of moves in inflation expectations.
Pandemics have generally not had this effect. The reason for this is clear. Over the long run, wars are the most common reason why governments run large budget deficits and are tempted to debase the currency. And wars that go wrong are especially likely to end in either debt default or inflation or both.
Thanks to the Bank of England, we can take a long, hard look at the history of British inflation expectations since the late 17th century. The striking point is that five out of the six biggest moves in expectations occurred in time of war — especially (as in 1917 and 1940) when the war was going badly.
Though the economics literature has little to say on the subject, I find it hard to believe that television news coverage of the deteriorating situation in Vietnam — for example, the Tet Offensive of 1968, which the U.S. networks misrepresented as a triumph for the North Vietnamese army and the Vietcong — played no part in the upward shift in American inflation expectations.
I would become a lot more worried about the prospects for U.S. inflation if our current Cold War II with China escalated into a full-blown hot war or even a serious diplomatic crisis over, say, Taiwan — which is a good deal more likely than I suspect most investors appreciate, as Robert Blackwill and Philip Zelikow pointed out last week.
Still, the British experience in the mid-1970s is a reminder that war is not a sine qua non for inflationary liftoff — or that the wars can be someone else’s, as was the case when the Arab states attacked Israel in 1973, the trigger for the oil shock that most people wrongly think of as the principal cause of the great inflation. Ultimately, inflation expectations can be untethered by a combination of excessive fiscal and monetary laxity without a shot being fired. If a pandemic has the financial consequences of a major war, that may suffice.
Lest anyone doubt the scale of the fiscal shock attributable to Covid-19, the latest projections from the Congressional Budget Office are now available. Even if the short-run outlook is less dire than last year’s exercise, the reality is inescapable: Not only is the federal debt in public hands now at its highest level relative to GDP since the year after World War II, but it is also forecast to soar to double that level by 2050. These are drastically worse projections than we were contemplating in 2009 and 2012.
The conclusion is not that inflation is inevitable. The conclusion is that the current path of policy is unsustainable. The Fed may control short-term rates but it cannot really allow long-term interest rates to rise rapidly because of the problems this would create for highly leveraged entities, including the federal government itself. This is the “unpleasant fiscal arithmetic” that inevitably arises when the stock of debt rises to approximately the level of total economic output.
On the other hand, the Fed cannot comfortably engage in full-spectrum yield-curve control without creating a situation of financial repression and fiscal dominance reminiscent of the late 1940s, another time of rapid inflation. To quote a recent paper from the St. Louis Fed, “if the Fed were to adopt such a policy and if the public perceives that the Fed is engaged in deficit financing, then it is possible that inflation expectations could rise.”
In the late 1940s and in the late 1960s, economic cooling was done by raising taxes. But no one in the new administration is talking about that, though the progressives in Congress are itching to tax the rich. On the contrary, the key members of Team Biden, notably Treasury Secretary Janet Yellen, all think the lesson of history is to “go large or go home” with deficit spending: the $1.9 trillion stimulus is the first of a number of big spending measures in prospect, with green new infrastructure next up. But that’s only the lesson of very recent history — to be precise, the first term of the Barack Obama administration, in which so many of today’s key players served.
In Charles Dickens’s “Great Expectations,” the orphan Pip comes into a fortune from an anonymous benefactor and embarks on the life of a gentleman — hence his great expectations. Only later does it become clear that the money comes from a dubious source and it ends up being lost altogether: “My great expectations had all dissolved, like our own marsh mists before the sun.”
It may ultimately be that our great expectations of inflation will dissolve in a similar way, vindicating Powell and making fools of aged economists and bond vigilantes alike. But the resemblances between our situation and the one Milton Friedman described in 1970 are striking — even if it is not quite true that inflation is always and everywhere a monetary phenomenon.
Going Down The Inflation Rabbit Hole
Should we be freaking out about inflation, or is everything a sign that economies are truly on the mend?
The Covid-19 pandemic has been the cause of countless sleepless nights. Now, it seems, inflation has begun robbing people of much-needed rest, just as good news about vaccines keeps rolling in. But is inflation really something we should be worrying about? Treasury yields have some market-watchers sweating, though Janet Yellen and Jay Powell have maintained calm as signs mount that the economy is truly in recovery. Maybe we’re justified in freaking out. Or maybe we all need a nap and some patience.
US Inflation Rate Accelerates In February, Could Go Higher As Economy Reheats
The 12-month rate represents an acceleration from January’s 1.4% clip, a pickup partly driven by higher gasoline price.
The U.S. Consumer Price Index (CPI) rose 0.4% in February, leaving it up 1.7% over the last 12 months, in line with economists’ expectations, a Labor Department report Wednesday showed.
The 12-month rate represents an acceleration from January’s 1.4% clip, a pickup partly driven by higher gasoline prices, which rose 6.9% in February, accounting for over half of the seasonally adjusted increase in the all-items index, according to the Labor Department’s Bureau of Labor Statistics.
* Core CPI, which excludes food and energy prices, rose 0.1% in February, the report showed. That level was just below economists’ average estimate of 0.2%, according to FactSet.
* Sub-indexes for shelter, recreation, medical care and motor vehicle insurance all increased in February.
* The energy index rose 3.9%.
* The index for airline fares continued to decline in February, falling 5.1% as consumers traveled less during the pandemic.
Pantheon’s Chief U.S. Economist, Ian Shepherdson, Wrote In A Note To Clients:
* “We are surprised by the softness of the core. Some of the components where we expected solid increases did deliver; owners’ equivalent rent, for example, rose 0.27%, the biggest increase since January last year and a further clear sign that the downward pressure on rents – 40% of the core – is fading.
Physicians’ services prices jumped 2.0% month-to-month, completing the adjustment implied by the 3.75% increase in Medicare reimbursement rates, effective January 1. But airline fares plunged 5.1%, despite soaring jet fuel prices, and hotel room rates dropped 2.3%, in contrast to the increase in room rates reported by STR, Inc., which tracks key hotel performance metrics. These declines can’t last. Finally, used auto prices fell by 0.9%, the fourth-straight big decline, widening the gap between the CPI measure and auction prices still further. Again, this does not seem sustainable.”
* Ian Sheperdson, chief U.S. economist at Pantheon
Rising inflation is closely watched by bitcoin (BTC) traders because a growing number of investors see the largest cryptocurrency as a hedge against higher prices. Federal Reserve Chairman Jerome Powell has suggested that inflation will rise in the coming months but the increase will likely be temporary.
Higher Gas, Energy Prices Boost Consumer Inflation At Start Of Year
Prices excluding gas and energy are flat so far this year, but economists expect government aid, vaccinations to drive short-term increase.
U.S. consumer prices picked up early this year as the pace of the economic recovery increased following a winter lull, buoyed by higher gasoline and energy costs.
The consumer-price index—which measures what consumers pay for everyday items including food, clothing, cars and recreational activities—increased a seasonally adjusted 0.4% in February from the prior month, the Labor Department said Wednesday.
Gasoline prices jumped 6.4% over the previous month, driving more than half of the overall increase, while electricity and natural gas prices rose 3.9%. New-vehicle prices were flat and used-vehicle prices fell for the fourth straight month, while apparel and medical care costs both fell.
The so-called core price index, which excludes the often-volatile categories of food and energy, rose 0.1% in February versus January, and was up 1.3% from the year prior. Core prices had remained flat over the previous three months.
The gain in overall prices marked a modest increase in inflation as demand for goods and services grew, and winter weather boosted energy consumption. In recent weeks, the number of coronavirus cases has eased following a winter surge, local governments have relaxed business restrictions and households have spent more.
Annual inflation also picked up, increasing by 1.7% in the year ended February, on a non-seasonally-adjusted basis.
February’s reading is the latest sign of an upswing in prices after nearly a year of muted overall inflation as the pandemic subdued consumer spending. The consumer-price index’s rise in 2020 was the smallest yearly increase since 2015.
Rates on long-term Treasury bonds, an indicator of expected inflation, have swept steadily upward in recent months, albeit from historic lows.
The promise of fresh fiscal spending in a $1.9 trillion pandemic relief package expected to clear Congress this week, along with rising vaccination rates, augur a bigger pickup in prices in coming months. Some economists say that inflationary pressures left unchecked could build into spiraling prices that, once set in motion, might be hard to quell.
Federal Reserve officials acknowledge that annual inflation is likely to rise in the coming months as the economy picks up. A spending surge after the economy more fully reopens, or supply-chain bottlenecks, also could cause some prices to jump.
But decades of slowing inflation due to globalization, technological advances and aging populations prompted the Fed last year to ditch its longtime practice of raising interest rates to pre-empt higher prices. Policy makers now plan to wait until inflation hits a 2% target and remains above it for some time before contemplating interest-rate increases.
More than 80% of economists surveyed by The Wall Street Journal said they expect inflation to rise above the Fed’s 2% target for a period of time due to the latest relief package. Economists in the survey said they see annual inflation rising to 2.8% by the middle of this year, then falling gradually after that.
“Our base case view is that the rise will be transitory—the Fed’s view as well—and does not represent the start of an upward spiral,” said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, a research firm. “Most critical will be the evolution of consumer and business inflation expectations, which we believe will remain well behaved and consistent with average 2% inflation over the medium term.”
Americans, too, expect prices to rise 3.1% over the coming year, the highest expected increase since July 2014, a survey released by the Federal Reserve Bank of New York found. Households projected that over the next year their spending will rise by 4.6%, up from 4.2% in January.
Prices for services, excluding energy, were up 0.2% on the month, driven by rising prices for medical care—in particular, physicians’ services. Services prices overall have been slower to rebound from pandemic lows than those for goods.
We May Be Entering A New Commodities Supercycle
Rising commodity prices have bank analysts and strategists asking if resurgent demand for raw materials and insufficient supply will create a new commodities supercycle. Price swings, of course, are as old as business itself. A commodities supercycle is different, though.
In the usual business cycle, demand pushes prices up, and supply increases to try to capture that windfall, sending prices down again. In a supercycle, supply is so inadequate to demand growth that prices rise for years, even a decade or more.
Before we examine the current possible supercycle, we should take a brief look back at the last two. In the 1970s, spiking oil prices created a boom that lasted into the early 1980s. In the early 2000s, China’s demand for copper, steel, aluminum, coal, and copper kept prices high through 2014, with a spike thanks to record high oil prices in 2008.
On this long timeline, we can just see the emergence of today’s possible supercycle.
Two components of this potential supercycle – oil and gas and metals – are relevant to decarbonization prospects. They’re also increasingly connected to each other.
First, oil and gas. One indicator in favor of a potential supercycle is the very low investment in oil and gas exploration. As prices fell from above $100 a barrel in 2014, capital expenditure fell, too. In real dollar terms, oil and gas capex is at about the same level as 15 years ago, when oil demand was 10% lower than at the end of 2020, and more than 15% lower than it was prior to the pandemic.
Two things could counteract that. Number one: If oil and gas prices rise consistently and the returns on capital increase, investors might demand more investment. Number two: Spare production capacity amongst the Organization of the Petroleum Exporting Countries spiked during the pandemic to more than 10 million barrels per day and remains far higher than at any point this century.
That spare capacity could be a release valve on high prices, as could a resurgence in U.S. shale production if prices are high enough to support new investment (and if capital markets are willing to fund it).
With the International Energy Agency predicting that global oil demand won’t rebound to pre-Covid levels until 2023, OPEC’s spare capacity could be very relevant—especially if oil demand has already peaked, as BP Plc said last year. That’s not to say that prices won’t keep increasing, but rather that the sector has mechanisms in place to meet demand.
Now, though, to metals, albeit in a roundabout way.
It’s always been true that rising oil prices will push consumers to seek alternatives. In the 1970s, oil was still widely used as a power generation fuel, and coal-fired generating capacity was added to replace it when oil prices soared. In transportation, however, alternative fuels and electric powertrains were pipe dreams.
This time, there are alternatives to oil in surface transportation which are technically effective, increasingly economically competitive, and globally available. The last time oil was $100 a barrel, in 2014, only 300,000 electric passenger vehicles were sold.
Last year, that figure was 3.1 million; this year, it’s likely to be closer to four-and-a-half million. The expanding EV fleet reduces oil demand; add in the world’s two- and three-wheel light electric vehicles, and buses, and we’re already looking at a million barrels a day of avoided oil demand as of 2019.
The world’s metals producers stand to benefit from increasing electrification, and not just in the transport sector. BloombergNEF estimates that global copper demand in both the clean power and the clean transport sectors will double in the next decades, to almost 5 million tons per year. Copper demand this year is expected to be about 24 million tons, so that jump would be a material increase.
As economists know, smart people have been saying “this time is different” for eight centuries and been proven frequently and thoroughly wrong. As we look today at the beginning of a possible commodities supercycle, we really should ask if this time is different.
This time, reducing demand for one commodity (oil) would boost demand for another (metals) in a way that really could be sustained for years or decades. The companies meeting that demand will be under increasing scrutiny, with investors and the public deeply interested in the environmental sustainability and carbon intensity of their extraction and processing.
If we enter a metals supercycle, it will be a cleaner one, with the potential to decarbonize part of the economy and reduce emissions in the process.
Ghost of Last Horrific Seven-year Treasury Auction Haunts Bond Market On Brink
A battered Treasuries market faces another trying week as it will have to absorb a massive slate of auctions focused in maturities that have gotten pummeled amid a brightening outlook for growth and inflation.
It’s been a month since a disastrous seven-year auction sent the bond market into a tailspin that reverberated across financial markets and helped put benchmark yields on the path to prepandemic heights. Now that maturity is on the calendar again, with a $62 billion offering looming as a source of anxiety for dealers in the week ahead.
The government will be selling into a market that’s endured a painful stretch, driving an index of longer maturities into a bear market. A key part of the yield curve just hit its steepest in over five years after the Federal Reserve reaffirmed plans to keep rates near zero through 2023. The seven-year area, especially vulnerable to shifting speculation on monetary policy, has taken a beating as traders bet the central bank won’t be able to wait that long. It’s underperforming surrounding maturities by the most since 2015.
“Supply is going to be a very important part of next week,” said Justin Lederer, a strategist at Cantor Fitzgerald.
“We’ll really see what type of end-user demand shows up at these auctions, and if the seven-year last month was so poorly sponsored because of volatility of that day or whether it’s a continued theme. There’s just a lot of volatility now and questions about whether higher rates are going to impact equities.”
In February, when investors were already stepping back from bonds amid stimulus talks and the vaccine rollout, the government received record-low demand for the seven-year auction. The result added fueled to a Treasuries selloff that’s extended to a seventh straight week.
The auction slate highlights another concern. Treasuries mostly shrugged off the Fed’s decision Friday to let lapse bank regulatory exemptions that have buoyed the bond market since the beginning of the pandemic. But dealers have been unloading Treasuries, and for some analysts the Fed’s move risks raising stress around auctions.
The fixed-income slump has hit longer maturities hardest. As of Thursday, a Bloomberg Barclays U.S. Treasury index that tracks debt with 10 years or more to maturity was down about 22% from its March 2020 peak, putting it in bear territory — at least by this gauge. The 10-year yield touched 1.75% this week, the highest since January 2020.
Treasuries Bull Market That Began in 1981 Has Finally Ended
Yields and inflation expectations also took flight after Fed Chair Jerome Powell pushed back on any need to combat the rise. A market proxy for inflation over the coming decade surged to about 2.3% this week, the highest since 2013.
Powell reiterated this week that he would only see an issue with the bond selloff if it were accompanied by “disorderly conditions in markets or by persistent tightening of financial conditions that threaten the achievement of our goals.” Tech shares appeared to suffer at points this past week as yields extended their climb.
That leaves traders monitoring a slew of Fed speakers ahead, especially Powell, for fresh insights. A continued message of patience on tightening rates could spark some to exit bets that hikes may come earlier than the Fed projects.
“I suspect the Fedspeak will stay in line with Powell’s views of this week, that they are letting inflation grow a bit and probably aren’t going to be moving rates or tapering asset purchases” for a long time, said Tom di Galoma, managing director of government trading and strategy at Seaport Global.
He expects 10-year yields to rise to around 1.9%-1.95% by mid-year, and he sees scope for 2.25% depending on the composition and size of any additional stimulus proposals.
Wall Street Pros From Goldman To Jpmorgan On New Inflation Era
It’s the invisible force rocking Wall Street: An inflation revival for the post-lockdown era that could change everything in the world of cross-asset investing.
As America’s dalliance with run-it-hot economics sends market-derived price expectations to the highest in more than a decade, Bloomberg solicited the views of top money managers on their make-or-break hedging strategies ahead.
One takeaway: The economics of trading from stocks and real estate to interest rates would be turned upside down if projections of runaway prices are to be believed.
Yet there are clear divisions. Goldman Sachs Group Inc. says commodities have proven their mettle over a century while JPMorgan Asset Management is skeptical — preferring to hide in alternative assets like infrastructure.
Pimco, meanwhile, warns the market’s inflation obsession is misplaced with central banks potentially still set to undershoot targets over the next 18 months.
The comments below have been edited for clarity.
Alberto Gallo, Partner And Portfolio Manager At Algebris
* Likes Hedges Including Convertible Bonds And Commodities
We don’t know at this point if the inflation pick-up will be sustained, but it’s a good start. What we do know is that markets are positioned completely the wrong way. Investors have been long QE assets like Treasuries, investment grade debt, gold and tech stocks. They’ve been long Wall Street and short Main Street for a decade.
There will be rotation into real-economy assets such as small caps, financials and energy stocks instead of rates and credit, and that will generate a lot of volatility. We like convertible debt in value sectors which are linked to an acceleration in the cycle. We also like commodities.
We are turning from an environment where central banks pushed the accelerator by keeping interest rates low while governments pulled the handbrake with austerity, to one where governments and central banks are now working together.
Thushka Maharaj, global multi-asset strategist at JPMorgan Asset Management
Prefers Real Assets Over Commodity And Price-Protected Bonds
Commodities tend to be volatile and do not necessarily offer good inflation protection. As for index-linked bonds, our study showed their long duration outweighs the pure inflation compensation this asset offers. It’s not the top asset on our list of inflation hedging.
If inflation were to rise and continue rising — and we think that’s a low probability event — equity sectors that are geared toward the recovery provide a good investment profile. We also like real assets and the dollar.
We are expecting volatility in inflation, especially at the headline level over the next few months, mostly over 2Q, driven by base effects, excess demand in the short term, and disruption in supply chains caused by a long period of lockdown. We see this as transitory and expect the central banks to look through the near-term volatility.
Christian Mueller-Glissmann, managing director for portfolio strategy and asset allocation at Goldman Sachs Group Inc.
* Issues Warning On Index-Linked Bonds And Gold
We found that during a high inflation backdrop, commodities, especially oil, are the best hedge. They have the best track record in the past 100 years to protect you from unanticipated inflation — one that’s driven by scarcity of goods and services, and even wage inflation like that in the late 60s. Equities have a mixed tracked record. We like value stocks as they are short duration.
The biggest surprise is gold. People often see gold as the most obvious inflation hedge. But it all depends on the Fed’s reaction function to inflation. If the central bank doesn’t anchor back-end yields, then gold is probably not a good choice as real yields might rise. We see index-linked bonds as in the same camp as gold.
A scenario of sustained inflation above 3% and rising is not our base case, but that risk has definitely increased compared with the previous cycle.
Nicola Mai, Sovereign Credit Analyst At Pimco
Says Inflation Might Undershoot Central Bank Targets Over Next 18 Months
Looking through near-term volatility introduced by energy prices and other volatile price components, we see inflation remaining low in the near-term, with central bank inflation targets elusive over the next 18 months or so. The global economy has spare capacity to accommodate rising demand. If the spending were to be increased steadily over years, however, this would likely end up in higher inflationary pressures.
We broadly like curve strategies and think U.S. TIPS offer reasonable insurance for an inflation overshoot. Commodities and assets linked to real estate should also benefit in an environment of rising inflation.
Mark Dowding, chief investment officer at BlueBay Asset Management
* Pares Duration Risk And Warns On Market Complacency
Real assets such as property and commodities will hold value best in inflationary situations. Duration exposure on bonds is not attractive as yields should head higher over a number of years if inflation normalizes at a higher level than we have been used to. The most overlooked risk is that there is too much complacency because everyone’s inflation expectations are anchored based on what they have witnessed in the past five to 10 years.
If there is a renewed economic slump, policy makers will be in a difficult position. Hence there is desire to make sure that you don’t miss targets on the downside. Like a golfer hitting a ball over a scary hazard, there is a temptation to go big! Ultimately this means that inflation outcomes should be higher not lower.
Fed Will Need to Buy Bonds as Stimulus Boosts Yields, Dalio Says
The U.S. Federal Reserve will need to buy more bonds as an oversupply of Treasuries drives up yields, said Ray Dalio, founder of Bridgewater Associates.
The recent fiscal stimulus announced by the Biden administration will result in more bond sales to finance the spending, worsening the “supply-demand problem for the bonds, which will exert upward pressure on rates,” Dalio said Saturday on a panel at the China Development Forum, an annual conference hosted by the Chinese government. That will “prompt the Federal Reserve to have to buy more, which will exhibit downward pressure on the dollar,” he said.
He said the world is “very overweighted in bonds,” and they are yielding minus 1 basis point in real terms, which is “very bad.”
“And not only might there be not enough demand, but it’s possible that we start to see the selling of those bonds,” he said. “That situation is bearish for the dollar.”
Fed Chair Jerome Powell said this week that current monetary policy is appropriate and there’s no reason to push back against a surge in Treasury yields over the past month.
IHS Price Gauges Rise To Records, Stoking U.S. Inflation Concern
Measures of prices paid and charged by U.S. businesses advanced in March to fresh records as shortages of materials and disrupted supply chains added to inflation concerns.
Firmer demand allowed companies to pass on just some of the higher prices paid for commodities, according to IHS Markit data issued Wednesday that also showed a measure of services activity at its strongest since July 2014.
Furthermore, the composite index of new orders at service providers and manufacturers was the firmest since September 2014.
At the same time, the IHS Markit composite gauge of input prices exceeded the prices charged measure by double-digits for only the second time in data back to 2009. That indicates only limited capacity to pass on higher costs to end-users and consumers, suggesting pressure on margins is developing.
Price pressures were also evident elsewhere. Input costs in the euro area rose at the fastest pace in a decade and selling prices for goods and services increased the most in more than two years, another IHS Markit survey showed Wednesday.
While the manufacturing gauge improved in March and matched the second-highest level in records back to mid-2007, supply shortages pushed down factory production growth to a five-month low.
The group’s flash composite index of output at both manufacturers and services eased to 59.1 in March after rising a month earlier to 59.5, which was the highest since August 2014. Readings above 50 indicate growth.
“Another impressive expansion of business activity in March ended the economy’s strongest quarter since 2014,” Chris Williamson, chief business economist at IHS Markit, said in a statement.
“The vaccine roll-out, the reopening of the economy and an additional $1.9 trillion of stimulus all helped lift demand to an extent not seen for over six years, buoying growth of orders for both goods and services to multi-year highs,” Williamson said.
The IHS Markit’s flash manufacturing PMI also showed supply shortages and shipping delays led to the longest delivery times in records back to 2007.
U.S. Durable Goods Orders Decrease For First Time Since April
Orders for U.S. durable goods unexpectedly declined in February for the first time in nearly a year, indicating a pause in the months-long manufacturing rebound.
Bookings for durable goods — or items meant to last at least three years — decreased 1.1% from the prior month, the first drop since April, after an upwardly revised 3.5% gain in January, Commerce Department figures showed Wednesday.
Core capital goods orders, a category that excludes aircraft and military hardware and is seen as a barometer of business investment, dropped 0.8% after an upwardly revised 0.6% gain. The median estimates in a Bloomberg survey of economists called for 0.5% increases in both total durables orders and core capital goods bookings.
The figures likely represent a temporary softening in the rebound seen across the nation’s factories since the pandemic upended production and demand last year. Production is still being restrained by shortages of some raw materials and supply chain disruptions that are also driving up costs for manufacturers.
“In all likelihood, the February results were suppressed by unusually harsh weather that substantially disrupted economic activity in much of the South and Midwest,” Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., said in a note. “There also could be an element of ‘digestion’ at play after very rapid gains in preceding months.”
Manufacturers are getting a tailwind from a gradual pickup in economic activity, still-lean inventories and robust business investment among companies. The report also showed unfilled orders for durable goods rose 0.8% in February, the most since September 2018.
Looking ahead, the latest stimulus package as well as future infrastructure packages should support investment.
The drop in overall durables was broad, including declines in bookings for motor vehicles, machinery and fabricated metals.
Other manufacturing data have been upbeat. The Institute for Supply Management manufacturing index hit a three-year high in February. And so far, March regional Federal Reserve manufacturing gauges have beat expectations. The Empire State general business conditions index rose to the highest level since November 2018 while the Philadelphia measure surged to the strongest since 1973.
Orders for commercial aircraft surged more than 103% in February from a month earlier. U.S. planemaker Boeing Co. reported 82 orders for the month, the second-best in two years.
Shipments of non-defense capital goods minus aircraft, a figure used to calculate investment in the government’s gross domestic product report, fell 1% in February, likely depressed by severe winter weather in the month.
Shoppers Start To See Effect Of Higher Commodity Costs
Huggies maker Kimberly-Clark to raise prices, joining General Mills, Hormel and others in passing along added cost.
Makers of everything from diapers to cereal are starting to feel the strain of higher commodity prices, and some are passing the added cost along to consumers.
Kimberly-Clark Corp. said Wednesday it plans to raise selling prices across much of its North America consumer-products business to help counter rising raw-material costs.
The maker of Huggies diapers and Scott paper products said the percentage increases would be in the mid- to high-single digits and take effect in late June. They will apply to the company’s baby- and child-care, adult-care and Scott bathroom-tissue businesses.
Consumer-products companies are already firming up prices for many staples as high demand for such items as paper towels, cleaning products and packaged food has meant fewer discounts.
Cheerios maker General Mills Inc. said it will raise prices to partly offset higher freight and manufacturing costs, in addition to rising commodity prices. “Our competitors and retailers are facing the same thing we are,” General Mills Chief Executive Jeff Harmening said.
Hormel Foods Corp. said in February it raised prices of its turkey products, such as Jennie-O ground turkey, to counter sharply higher grain costs. If the rally in the commodity markets were to continue, the company would likely pass along further increases, Chief Executive Jim Snee said. Hormel also raised prices of its Skippy peanut butter.
J.M. Smucker Co. said it recently raised prices for its Jif peanut butter and that it might do the same with pet snacks because of higher shipping costs and other inflationary pressure. Smucker Chief Executive Mark Smucker said retailers are passing increases along to consumers. “We only raise prices when costs are meaningfully higher, and we partner with the retailers to make sure it’s justified and that we move together,” he said.
Kimberly-Clark said its increases, which will be implemented almost entirely through changes in list prices, are needed to help offset significant commodity cost inflation.
The company in January warned of commodity inflation of $450 million to $600 million in 2021, expecting costs to rise for materials like pulp, recycled fiber and resin. At that time, Chief Executive Michael Hsu said the company wasn’t planning for broad-based increases to list prices.
The company said pulp and polymer resin are experiencing shortages.
The last time the Kimberly-Clark raised prices significantly enough to warrant a public statement was 2018 when surging pulp prices drove up the cost of diapers, toilet paper and other products.
“The pricing plans we outlined in January were based on the commodity inflation outlook we provided at that time, so it’s fair to say that we wouldn’t be announcing these price increases if the commodity environment hadn’t worsened,” a company spokesman said Wednesday.
Since then, global supply chains, which were already experiencing a crunch due to the Covid-19 pandemic, have seen additional disruptions. The February freeze that triggered mass blackouts in Texas led to chemical plant shutdowns and caused a shortage of the raw materials needed for everything from medical face shields to smartphones.
As a result, prices for polyethylene, polypropylene and other chemical compounds reached their highest levels in years in the U.S. as supplies tighten.
Inflation is poised to leap higher in the next few months following on a sharp dip in prices a year ago, Federal Reserve Chairman Jerome Powell said in March.
“We could also see upward pressure on prices if spending rebounds quickly as the economy continues to reopen, particularly if supply bottlenecks limit how quickly production can respond in the near term,” Mr. Powell said. “However, these one-time increases in prices are likely to have only transient effects on inflation.”
Shipowners, exporters and importers are now racing to secure berths and containers at ports while warning of delays and higher costs for cargoes after engineers freed the Ever Given, a 1,300-foot container ship that had been stuck in the Suez Canal.
In the U.S., container ships anchored off the Southern California coast are waiting for space at the ports of Los Angeles and Long Beach. The ships are carrying tens of thousands of boxes holding millions of dollars’ worth of washing machines, medical equipment, consumer electronics and other goods that make up global ocean trade.
U.S. Producer Price Inflation Posts Biggest Annual Increase Since 2011
The numbers: The producer price index rose 1% in March, the U.S. Labor Department said Friday. Economists polled by the Wall Street Journal had forecast a 0.5% rise.
The rate of wholesale inflation over the past 12 months climbed to 4.2% in March. That’s the highest level since September 2011. Because PPI was so weak last spring, increases this year are going to push the annual readings higher for at least a few months.
The government did not release the data for 25 minutes after the scheduled release time on its website, an extraordinary delay of economic data that is focus of global financial markets. The Labor Department no longer allows reporters access to the data in a secure room without communication tools to allow analysis of the data ahead of the publication time.
A spokesman for the BLS declined to comment regarding the delay.
What happened: Most of the increase in producer prices last month was tied to higher costs of energy, which jumped 5.9%. Chemical and steel-related products also rose sharply.
Core prices, which strip out volatile foods, energy and trade prices, rose 0.6% in March and were up 3.1% year-on-year, its highest level since September 2018.
Big picture: The data show that supply-chain issues combined with recovering demand is placing upward pressure on a broad array of prices at the producer level, said Josh Shapiro, chief U.S. economist at MFR Inc. Federal Reserve officials expect these gains will be temporary.
What are they saying? The pandemic has put producer prices on a rollercoaster,” said Bill Adams, senior economist at PNC Financial Services Group. At first prices plunged but have now jumped back, he said. In the near-term, PPI inflation will accelerate but then should slow later in the year, Adams said.
US Inflation Rises Faster Than Expected In March, But Unlikely To Deter Fed
US March inflation beat expectations, but Fed likely to remain unmoved. Bitcoin traders continue to hedge.
U.S. headline inflation rose to a 12-month pace of 2.6% in March, the Labor Department’s Bureau of Labor Statistics reported in its latest CPI report, accelerating from the 1.7% increase reported last month.
The pace exceeded economists’ average estimate for a 2.5% increase.
The gauge of consumer prices is now rising at its fastest since August 2018, largely due to base effects from the pandemic-induced recession that rattled the economy a year ago, when the lockdown-induced drop in demand sent costs tumbling for many goods and services.
The CPI report is particularly important for some cryptocurrency investors who view bitcoin (BTC) as a hedge against inflation and ongoing currency debasement. However, concerns about higher inflation beyond the 2% threshold could cause the Federal Reserve to consider tightening monetary policy, which could weigh on risk assets.
Federal Reserve Chairman Jerome Powell has said he views higher inflation as temporary and not enough for the U.S. central bank to alter its record-low interest rate policies.
* On a month-to-month basis, headline March CPI increased 0.6%, beating expectations for a 0.5% rise after rising 0.4% in February.
* The March 1-month increase was the largest rise since a 0.6% increase in August 2012, according to the U.S. Bureau of Labor Statistics.
* The gasoline index continued to increase, rising 9.1% in March, and accounted for nearly half of the seasonally adjusted increase in CPI.
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