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.”
Inflation Is Coming. That Might Even Be A Problem
Upward pressure on prices is already easy to spot, and that’s before the Democrats take over.
Inflation is probably coming to the U.S. this year. The question is how much. Prices rising faster than the Fed’s 2% target would be welcome, but too much price growth could be a problem. If that happens, the Federal Reserve could be in a bind.
The Democrats’ surprising victory in the Georgia Senate elections this month is just part of the reason to expect prices to rise. Just the expectation that Democratic control of the White House and Congress will result in more spending on economic stimulus programs sent inflation expectations climbing above 2% last week for the first time since 2018.
An increase in the supply of government bonds — which will finance the extra spending — pushes up yields, and the 10-year Treasury yield rose above 1% last Wednesday for the first time since the early days of the coronavirus pandemic.
Economic growth is almost sure to surge this year as the pandemic begins to recede, but the Federal Reserve has convinced market participants that it will keep short-term interest rates low. That could be inflationary, too.
And add to the list the Fed’s new monetary policy framework, which is designed to allow for above-target inflation for temporary periods. This more permissive attitude could change what households and investors expect from prices and from the central bank. This in turn could create a self-fulfilling situation in which expectations about faster price growth push up actual prices.
Some economists believe that inflation is largely determined by the amount of money sloshing around in the economy. Despite the Fed’s aggressive measures following the global financial crisis in 2008, financial assets held by households — including currency, checking and savings accounts and other liquid assets — did not rapidly increase because banks were reluctant to lend.
In contrast, this measure of the stock of money (called “M2”) has increased sharply in the pandemic, rising from $15.4 trillion in late January to over $19 trillion at the end of December. This may be another reason to expect upward pressure on prices.
In addition to these considerations, the pandemic has caused supply-chain bottlenecks that should put upward pressure on prices. Last month, my delivery of live Christmas garlands was delayed for this reason, and I was told by the vendor that a black market in wreaths had sprung up in its wake. Because they were harder to get, their price went up.
Costs are also rising. Metals, including iron ore and copper, have gotten more expensive, as have commodities like cotton and lumber. Since these are purchased by manufacturers to make other goods, their rising prices put upward pressure on consumer prices. In addition, the dollar has been depreciating since the spring, which also creates inflationary pressure by raising the cost of many kinds of production.
The productive capacity of the economy has been diminished by the pandemic, as well. Businesses have failed, long-term unemployment has increased and workers and capital will need to be reallocated as the economy recovers. This will act to further restrain supply as demand rises.
And demand will surely strengthen because households are sitting on piles of cash. The personal savings rate averaged 7.3% from the end of the 2008 recession until the onset of the pandemic. In April, it hit a peak of 33.7%. In November, the rate was still 12.9%. Once people get vaccinated and feel safe engaging in a broader range of economic activity, many will want to go on spending sprees.
But while it’s easy to be confident that inflationary pressures will rise, it’s harder to predict how much impact those pressures will have on actual prices. Recent history doesn’t give much support to the theory that inflation has to be a byproduct of economic expansion or accommodative macroeconomic policy.
From June 2009 through the beginning of the pandemic recession in March 2020, the year-over-year monthly inflation rate as measured by a key price index — the deflator for personal consumption expenditures, excluding volatile food and energy prices — averaged 1.6%. In the years since the 2008 recession ended, the rate of inflation has only hit the Federal Reserve’s 2% target in 13 months.
And that’s despite a recovering economy and extraordinary efforts to stimulate it — including keeping the federal funds rate near zero for six years and purchasing trillions of dollars of assets to encourage home buying. The unemployment rate fell from 10% in October 2009 to 3.5% in February 2020.
There are also pressures pushing back against an inflation surge. The economy will still be weak throughout 2021, despite impressive quarterly growth rates and falling unemployment. Slack in labor markets should restrain wage growth, which will put downward pressure on consumer prices. The latest inflation data, released Wednesday, show that that core consumer prices grew slightly more slowly in December than in November, probably for this reason.
Still, I’m expecting some inflation. How large will the surge be? Here, predictions become difficult because inflation dynamics are still not well understood. Two-percent inflation is currently expected by investors. A rate of 3% over a short time should, in my view, be considered a policy victory by the Fed and Congress, because it would suggest that their efforts to stimulate and support the economy are working.
I think this range is completely plausible. It’s worth noting that inflation in the 3% range is higher than investors currently expect.
Could prices go even higher? At 4%, economists and policy makers may start to get worried that price increases are getting out of hand. Inflation can spike rapidly. And once inflation has taken hold, it can be painful to get price growth back under control.
Especially worrisome is the possibility that price growth starts to make economists and investors jittery while the economy is still weak. This would put the Fed in a difficult bind, having to choose between acting to preempt a damaging surge of inflation and allowing the benefits of the recovery to reach low-wage workers and low-income households.
I’d be surprised if this happens. But as the saying goes, predictions are hard, especially about the future. The Fed should prepare itself to be in precisely this situation.
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.
Nowhere To Hide From Inflation Fears As Commodities Join Rout
Even commodity futures aren’t safe from the inflation fears that are gripping global markets. Crude oil plunged 7%, coffee had its biggest loss in two months, while corn and copper also tumbled.
Fresh concerns that the Federal Reserve will let inflation accelerate sparked a selloff in most risk assets on Thursday. U.S. equities dropped from records and Treasury yields jumped. Those moves spilled over into commodities, with physical demand heavily tied into global growth expectations.
Still, it was a bit of a paradox for commodities. The markets can sometimes benefit from an inflationary environment since investors think of the raw materials as a good place to find yield. But the inflation equation needs to be just right: Too much, especially if it’s coupled with concerns over economic growth and a higher dollar, and the inflation boost quickly turns into a drag amid deflated demand expectations.
Commodities had a supercharged start to the year that saw crude surge more than 30% through Wednesday. Corn, soybeans and copper reached multi-year highs and lumber prices skyrocketed. Bulls took such a command that some traders were gearing up for a new supercycle of prolonged gains.
That enthusiasm has come to a halt this week as slow vaccine rollouts sparked concern over how long it will be before consumption of energy, metals and grains returns to pre-pandemic levels. That was compounded by gains in the dollar, which make greenback-priced commodities less attractive as a store of value.
“Treasury yields and the dollar are responding to the Fed, and that is currently having a negative impact on the commodities,” Arlan Suderman, chief commodities economist at StoneX, said in an email.
The Bloomberg Commodity Spot Index slumped 2.4%, the biggest drop since mid-September.
West Texas Intermediate crude futures declined for a fifth session, the longest stretch of daily losses in more than a year. Global oil demand won’t return to pre-pandemic levels until 2023, and growth will be subdued thereafter amid new working habits and a shift away from fossil fuels, the International Energy Agency said this week.
Grain prices also fell. There are signs of improving growing conditions for some crop producers. Beneficial rains for soybeans in Argentina weighed on the market, while favorable weather in the U.S., Russia and Ukraine pressured wheat prices.
Meanwhile, the gains for Treasury yields hurt demand for alternative assets like gold and silver, which don’t bear interest.
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.
Kimberly-Clark Slides As Inflation Hurts Toilet Paper Maker
Kimberly-Clark Corp.’s shares fell after the maker of household supplies missed Wall Street’s expectations for second-quarter earnings and trimmed its annual forecast, saying inflationary pressures and slowing toilet paper demand are hurting results.
Profit this year will be $6.65 to $6.90 a share, the company said Friday in a statement, down from a prior expectation of as much as $7.55. It also reduced its projection for net sales growth to a range of 1% to 4%.
“We are facing significantly higher input costs and a reversal in consumer tissue volumes from record growth in the year ago period as consumers and retailers in North America continued to reduce home and retail inventory,” Chief Executive Officer Mike Hsu said in the statement. The company has raised prices “to mitigate inflationary headwinds.”
The difficult quarter highlights the challenge of maintaining momentum for makers of household staples, which saw sales surge amid consumer stockpiling early in the pandemic. As demand returns to a more normal level, companies are also contending with rising commodity costs and supply chain problems. Like many companies, the maker of Cottonelle raised prices to offset the impact.
The shares fell 3% at 9:56 a.m. in New York. Kimberly-Clark’s stock was essentially unchanged this year through Thursday’s close.
What Bloomberg Intelligence Says
“Cutting marketing and other spending to soothe some margin pain could impede Kimberly-Clark’s midterm volume recovery, as a souring outlook raises questions about whether premium launches in personal care are enough to offset faster-than-expected consumer-tissue sales declines and pulp inflation.”
–Diana Gomes, Consumer-Products Analyst
In the second quarter, organic sales, which strips out items like acquisitions and currency effects, fell 3%. Analysts had expected a decline of 0.88%, based on the average of estimates compiled by Bloomberg. Adjusted earnings slid to $1.47 a share, short of Wall Street’s expectations.
The “brutal quarter” included the worst gross margin compression in at least 20 years, Bernstein analyst Callum Elliott said in a note.
Kimberly-Clark’s consumer tissue business faced a tough comparison from last year’s spike, with quarterly sales tumbling 13%. The company attributed the decline to lower retail shipments as reopening economies and pantry destocking muted demand. The unit’s sales in North America plunged 26%.
There were some bright spots, including a pickup in the K-C Professional business as workers increasingly return to offices. The unit’s revenue rose 6%.
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.
Lumber Prices Soar. Demand For Wood Is Skyrocketing And Shares Of Wood Suppliers Are Surging
Lumber prices have soared to records. Demand for wood is skyrocketing. The shares of wood suppliers are surging.
And yet, trees themselves are dirt cheap in places like Louisiana, where timber supplies are plentiful.
The so-called stumpage fee, or what lumber companies pay to land owners for trees, for Louisiana pine sawtimber on March 31 was $22.75 per short ton, according to the latest data from price provider TimberMart-South. That’s the lowest since 2011.
An abundance of harvest-ready trees has kept stumpage fees extremely low across the U.S. South, home to half of the country’s production. Meanwhile, lumber futures are up 85% in 2021 because of soaring demand. Sawmills profit from the premium lumber commands over the stumpage fee — think of it like the lumber crack spread.
Those margins are exploding. The spread between futures and stumpage for Louisiana pine, for example, has more than doubled just this year, topping $1,100 per 1,000 board feet.
Harvest-ready trees exceed sawmill capacity throughout the southern U.S. Since it’s so expensive to transport heavy logs, supplies go to sawmills in the area and the fees are highly localized in the region, where many timberlands are privately owned.
In Alabama, the stumpage fees are slightly higher than Louisiana at $23.34 per short ton. But they’ve barely budged since 2016 and are half the price fetched in 2005.
In the futures market, lumber touched a record $1,326.70 per 1,000 board feet on Monday.
That sent the spread between futures and the Louisiana stumpage fee higher than $1,144 per 1,000 board feet on Monday, based on a calculation that assumes 8 short tons of logs per 1,000 board feet.
By comparison, during the last lumber surge (in the first half of 2018), the spread topped out just above $440.
“If you can source the lumber, you’re making a whole bunch of money right now,” Stinson Dean, chief executive officer of Deacon Lumber Co., said in an interview on Bloomberg Television last week.
The margin calculation is similar to the oil market’s famed crack spread, or the price at which gasoline trades over crude, and doesn’t account for the expense of processing logs into lumber cuts like plywood or two-by-fours.
Lumber Frenzy Drives Up Home Prices as Suppliers Can’t Keep Up
Lower stumpage fees are beefing up profits for sawmills as a frenzy for home-renovation and building has sparked an unprecedented surge in demand for lumber. And mills are cranking it out to take advantage of the unusually high margins, with those in the South running at about 93% of capacity, according to Forest Economic Advisors LLC.
“As soon as the supply disruptions sort themselves out and everything gets back to normal, we expect a major correction in prices,” said Joshua Zaret, a senior analyst at Bloomberg Intelligence. “But right now, if you’re producing lumber in the U.S. South — or anywhere for that matter, but particularly in the U.S. South, where your log cost hasn’t come up — it’s very profitable.”
Investors are rewarding the mills. Shares of West Fraser Timber Co., the world’s biggest lumber supplier, have tripled in the past 12 months in Canada trading.
Still, there are signs that margins could start to shrink later this year and into 2022 as sawmill capacity expands and eats into the tree glut.
Forest Economic Advisors estimates capacity for mills in the U.S. South at 23.6 billion board feet. As much as 1.5 billion board feet of new capacity is expected to come online over the next year or two.
Despite Lumber Boom, Few New Sawmills Coming
Lumber companies say they are content to rake in cash as wood prices soar. They aren’t racing out to build new mills though.
North America’s sawmills can’t keep up with demand, which has sent wood prices on a meteoric rise. Don’t expect new mills to start popping up though.
Executives in the cyclical business of sawing logs into lumber said they are content to rake in cash while lumber prices are sky-high and aren’t racing out to build new mills, which can cost hundreds of millions dollars and take two years to build from the ground up.
In doing so they are breaking with conventional wisdom in the commodities business, which states that the cure for high prices is high prices. Usually when prices for raw materials rise, refineries and smelters ramp up, farmers plant larger crops, wells are drilled, mines dug. New supplies flood into the market and prices retreat.
Home buyers and do-it-yourself-ers, who are paying more than four times the normal price for lumber, would like for that to happen. But they are flush thanks to historically low borrowing costs, rising home values and government stimulus. Demand has been unbowed by escalating prices.
Lumber futures have fallen from last week’s all-time highs, when two-by-fours for May delivery hit $1,711.20 per thousand board feet. Yet with July futures ending Monday at $1,327.00, they remain more than twice the pre-pandemic record. Meanwhile, cash prices for framing lumber and structural panels reached new highs, according to pricing service Random Lengths.
Mill companies including Weyerhaeuser Co. and West Fraser Timber Co. have set nine-figure budgets to boost efficiency and output at their existing mills, particularly in the South where there is a glut of cheap pine timber. Some forest-products executives said they are considering acquisitions with their fast-accumulating cash. But there aren’t many new mills on the drawing board for North America.
“We are going to be ultra cautious on what we do in those regards,” Canfor Corp. Chief Executive Don Kayne told investors last month when the company reported record quarterly profits. “We don’t mind at all having a little extra cash around for sure, considering what this industry goes through.”
U.S. lumber-making capacity has risen about 11% over the past five years, according to Forest Economic Advisors LLC. New mills in the pine belt between Georgia and east Texas have helped offset closures that have shrunk Canada’s capacity, but there isn’t much coming behind them. Idled facilities are restarting in Florida and Mississippi. A couple small mills are under construction out West. Four bigger mills have been announced but not begun in the South, the firm said.
Chad Hesters, who advises forest-product executives and investors as managing partner in the Houston office of consulting firm Korn Ferry, said the lumber boom has prompted clients to ask about building mills. He said he tells them they are too late.
Besides the time and money it takes to build a modern mill, equipment, from microprocessors to heavy machinery, is in short supply. So are the sort of workers needed to operate a computerized mill, especially in the rural places where timber is abundant, Mr. Hesters said.
“Trying to build capacity and make investments that have a lot of lead time at the top of a cycle is historically a good way to lose money,” Mr. Hesters said.
U.S. wood-product manufacturing peaked in January 2006, according to the Federal Reserve. A sharp decline that year foreshadowed the housing market’s collapse. The least efficient mills shut down while others were consolidated. Big Canadian sawyers West Fraser, Canfor and Interfor Corp. have spent billions of dollars modernizing mills in the Southern pinelands ever since.
An example is in Summerville, S.C., where Interfor is boosting output at a lumber mill that it bought in March from a cardboard maker. The lumber boom has pushed up asking prices for mills, though, which may impede deals like that, forest-product executives said.
Meanwhile, stock analysts are advocating for mill companies to return cash to shareholders.
BMO Capital Markets analyst Mark Wilde said it is hard to see how mill companies can spend their windfalls without destroying value, given the frothy market.
“It’s a lot of sailors hitting the town with a lot of money in their pocket, so silly things can happen,” he said on Canfor’s earnings call. He applauded Interfor’s move Wednesday to pay a special dividend of $1.65 a share.
Added shifts and new equipment should increase output on the margins, but mill executives expect supplies to remain tight and for prices to remain high into next year.
“Even if there was an opportunity to build inventories, distribution channels would be reluctant at current market prices,” said Bart Bender, Interfor’s head of sales and marketing.
Companies that buy wood from mills to distribute to builders, manufacturers and retailers have been limiting orders to exactly what customers need for fear of getting stuck with high-price inventory and falling prices, said Michael Goodman, whose family owns and operates Sherwood Lumber Corp.
The Melville, N.Y., company annually sells about a billion board feet of framing lumber to truss manufacturers, building-supply companies and shipping-crate makers. The firm doesn’t expect additional supplies before late next year or even 2023 and has been trying to manage its risk in the white-knuckle market by taking positions in the futures market.
“This is our job,” Mr. Goodman said. “We’re a middleman. We can’t not have stuff on the shelf.”
Procter & Gamble Will Raise Prices in September
Price increases on baby products, adult diapers and feminine-care brands come as the company reports slowing growth in latest quarter.
Procter & Gamble Co. PG 0.83% this fall will start charging more for household staples from diapers to tampons, the latest and biggest consumer-products company to announce price hikes.
The maker of Gillette razors and Tide detergent cited rising costs for raw materials, such as resin and pulp, and higher expenses to transport goods.
The announcement, which came as P&G disclosed its quarterly financial results, follows a similar move last month by rival Kimberly-Clark Corp.
P&G said organic sales grew 4% in the quarter ended March 31, with the biggest gains in the company’s beauty and fabric and home-care units.
The results mark P&G’s slowest overall organic sales increase since 2018, following a year in which the Covid-19 pandemic created high demand for products such as cleaning supplies, paper towels and toilet paper.
“It’s a different situation, as everywhere in the world countries are in very different places as far as coming out of the pandemic,” operating chief Jon Moeller said in an interview. “There is very strong consumption across the board.”
While sales are cooling for some products, Mr. Moeller said, demand is recovering for others, such as beauty products and supplies sold directly to businesses that are reopening after widespread shutdowns.
Mr. Moeller said P&G aims to improve and add features to products, as the company increases prices so that consumers feel they are getting more. The price increases, to take effect in September, will be on baby products, adult diapers and feminine-care brands and will be in the mid- to high-single-digit percentage points, the company said.
The last time big consumer-products companies raised prices significantly because of materials costs was 2018, when surging pulp prices drove up the cost of diapers, toilet paper and other products.
Kimberly-Clark, maker of Huggies diapers and Scott paper products, said its 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.
Several food makers have raised prices as well. Hormel Foods Corp. said in February that it raised prices on its turkey products, such as Jennie-O ground turkey, in response to higher grain costs. 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.
The Labor Department said last week that its consumer-price index—which measures what consumers pay for everyday items, including groceries, clothing, recreational activities and vehicles—jumped 2.6% in the year ended March, the biggest 12-month increase since August 2018.
During the quarter, P&G’s net sales rose 5% to $18.1 billion, above the consensus forecast of $18 billion from analysts polled by FactSet. Volume was flat for the first time in years, while price and mix both increased 2%.
P&G posted net income of $3.27 billion, or $1.26 a share, up from $2.92 billion, or $1.12 a share, a year earlier. Analysts expected net income of $3.09 billion.
The company maintained its forecast of organic sales growth of 5% to 6% for the fiscal year that ends June 30.
Lumber Extends Record Rally With Order Surge Straining Sawmills
Lumber futures extended a record rally as sawmills struggle to meet insatiable demand, with the biggest U.S. producer saying it’s sold out of some key homebuilding materials for the next several weeks.
Prices have quadrupled in the past year, buoyed by an unexpected surge in home building and renovations that caught sawmills off guard with low inventories. Demand has held strong since mid-June, keeping inventories low and costs high. That’s expected to have spurred record earnings for some lumber producers while adding more fuel to surging house prices.
Builders are scrambling to buy the wood products that they need, and paying increasingly high prices that they must pass along to home buyers as North America heads into its peak building season. The lumber rally has lifted the price of an average new single-family home by $35,872 over the past 12 months, according to the National Association of Home Builders.
Weyerhaeuser Co. Chief Executive Officer Devin Stockfish, speaking to analysts on Friday after the company reported record quarterly profit, said it’s sold out of oriented strand board, a cheaper and widely used stand-in for plywood, for the next five to six weeks. For lumber, the order book is sold out for the next two to three weeks, he said.
“We’re essentially off the market into the third quarter at this point, so those order files are really extended” in engineered wood products, Stockfish said. “On OSB, we’re five to six weeks out, so really at the outer edge of what we’re comfortable with in terms of order files. Even on lumber, we’re two to three weeks at this point, which for lumber is on the high end of where we typically have order files.”
Resolute Forest Products Inc. said Thursday it restarted a mill in Ontario that had been idle for two years, as well as one in Arkansas, and was running two shifts to keep up with demand. Weyerhaeuser said it expects strong residential building will keep wood demand high this year, and that the company will funnel more of its logs into the U.S. market to benefit from high prices.
The surge in lumber has ratcheted up expectations for forest-products company earnings. Weyerhaeuser’s results were slightly below estimates and shares dropped by as much as 6.6%.
While builders appear to be successfully passing along higher costs to home buyers, both Canfor Corp. and Weyerhaeuser executives expressed concern about soaring homebuilding and renovation costs.
“So far we haven’t seen the resistance you would expect,” Kevin Pankratz, senior vice president of sales and marketing for Canfor, said on a call with analysts Friday. “We do worry about that longer term, with respect to inflation and potential impact on demand destruction.”
Weyerhaeuser’s second-quarter outlook is “constructive” and will likely be its best ever, BMO Capital Markets analyst Mark Wilde said in a report.
Lumber futures for July delivery jumped by the exchange maximum $48, or 3.6%, to a fresh record high for the most-active contract of $1,376.50 per 1,000 board-feet on the Chicago Mercantile Exchange.
Cryptos Are A Threat to Central Banks. Why It Goes Beyond Bitcoin
Most of us go to the Bahamas for the sun and surf. Central bankers may be visiting for another reason: to check out the country’s new digital currency, the Sand Dollar. The Bahamas is one of three countries to launch a digital currency, along with China and Cambodia. Sand Dollars are now loaded in mobile wallets on smartphones; to buy a beer, simply scan a QR code—more convenient than swiping a credit card or using a grubby dollar bill.
Digital currencies aren’t yet widespread, but a race is on to get them into circulation as battle lines harden between cryptocurrencies and standbys like the dollar.
More than 85% of central banks are now investigating digital versions of their currencies, conducting experiments, or moving to pilot programs, according to PwC. China is leading the charge among major economies, pumping more than $300 million worth of a digital renminbi into its economy so far, ahead of a broader rollout expected next year. The European Central Bank, Bank of Japan, and Federal Reserve are investigating digital currencies. A “Britcoin” may eventually be issued by the Bank of England.
Sweden is lining up an e-krona and might be the first cashless nation by 2023.
Money already flows through electronic circuits around the globe, of course. But central bank digital currencies, or CBDCs, would be a new kind of instrument, similar to the digital tokens now circulating in private networks. People and businesses could transact in CBDCs through apps on a digital wallet.
Deposits in CBDCs would be a liability of a central bank and may bear interest, similar to deposits held at a commercial bank. CBDCs may also live on decentralized ledgers, and could be programmed, tracked, and transferred globally more easily than in existing systems.
New cryptocurrencies and payment systems are raising pressures on central banks to develop their own digital versions. Bitcoin, while popular, isn’t the main threat. It’s highly unstable—more volatile than the Venezuelan bolivar. Many investors sock it away rather than use it, and the underlying blockchain network is relatively slow.
But the cryptocurrency market overall is gaining critical mass—worth $2.2 trillion in total now, with half of that in Bitcoin.
Central bankers are particularly concerned about “stablecoins,” a kind of nongovernmental digital token pegged at a fixed exchange rate to a currency. Stablecoins are gaining traction for both domestic and cross-border transactions, particularly in developing economies.
Technology and financial companies aim to integrate stablecoins into their social-media and e-commerce platforms. “Central banks are looking at stablecoins the way that taxi unions look at Uber—as an interloper and threat,” says Ronit Ghose, global head of banks research at Citigroup.
While many stablecoins are now circulating—the largest is Tether, with $51 billion in circulation, versus $2.2 trillion for the dollar—a big one may be arriving soon in Diem, a stablecoin backed by Facebook (ticker: FB). Diem may launch this year in a pilot program, reaching Facebook’s 1.8 billion daily users; it’s also backed by Uber and other companies.
The potentially rapid spread of Diem is raising the ante for central bankers. “What really changed the debate is Facebook,” says Tobias Adrian, financial counsellor at the International Monetary Fund. “Diem would combine a stablecoin and payments platform into a vast user base around the world. That’s potentially very powerful.”
The broader force behind CBDCs is that money and payment systems are rapidly fracturing. In the coming years, people might hold Bitcoin as a store of value, while transacting in stablecoins pegged to euros or dollars. “The private sector is throwing down the gauntlet and challenging the central bank’s role,” says economist Ed Yardeni of Yardeni Research.
The dollar won’t disappear, of course—it’s held in vast reserves around the world and used to price everything from computers to steel. But every fiat currency now faces more competition from cryptos or stablecoins.
And stablecoins in widespread use could upend the markets since they aren’t backstopped by a government’s assets; a hack or collapse of a stablecoin could send shock waves as people and businesses clamor for their money back, sparking a bank run or financial panic. And since they’re issued by banks or other private entities, they pose credit and collateral risks.
As commerce shifts to these digital coins, along with other cryptocurrencies and peer-to-peer networks, governments risk losing control of their monetary policies—tools that central banks use to keep tabs on inflation and financial stability. “Central banks need to create digital currencies to maintain monetary sovereignty,” says Princeton University economist Markus Brunnermeier.
The Fed, for instance, manages the money supply by buying or selling securities that expand or contract the monetary base, but “if people aren’t using your money, you have a big problem,” says Rutgers University economist Michael Bordo.
It isn’t all about playing defense, though. Proponents of CBDCs say there are economic and social benefits, such as lower transaction fees for consumers and businesses, more-effective monetary policies, and the potential to reach people who are now “unbanked.”
CBDCs could also help reduce money laundering and other illegal activities now financed with cash or cryptos. And since central banks can’t stop the rise of privately issued digital money, CBDCs could at least level the playing field.
While CBDCs have bounced around academia for years, China’s pilot project, launched last year, was a wake-up call. Analysts say China aims to get its digital renminbi into circulation for cross-border transactions and international commerce; the standard renminbi now accounts for 2.5% of global payments, well below China’s 13% share of global exports, according to Morgan Stanley.
In China, transactions on apps like Alipay and WeChat now exceed the total world volume on Visa (V) and Mastercard (MA) combined. The Chinese apps have also become platforms for savings, loans, and investment products. CBDCs could help regulators keep tabs on money flowing through the apps, and help prevent stablecoins from usurping the government’s currency. “That’s why the People’s Bank of China had to claim its property back—for sovereignty over its monetary system,” says Morgan Stanley chief economist Chetan Ahya.
Momentum for digital currencies is also building for “financial inclusion”—reaching people who lack a bank account or pay hefty fees for basic services like check cashing. About seven million U.S. households, or 5% of the total, are unbanked, according to the Federal Deposit Insurance Corp. Democrats in Congress recently proposed legislation for a digital-dollar wallet called a FedAccount, partly to reach the financially disadvantaged.
Governments could also target economic policies more efficiently. Stimulus checks could be deposited into e-wallets with digital dollars. That could bypass checking accounts or apps that charge fees. It could be a way to get money into people’s hands faster and see how it’s spent in real time. Digital currencies are also programmable. Stimulus checks in CBDC could vanish from a digital wallet in three months, incentivizing people to spend the money, giving the economy a lift.
Researchers at the Bank of England estimate that if a digital dollar went into widespread circulation, it could permanently lift U.S. output by 3% a year. That may be a stretch, but central banks, including the Fed, are now building systems for banks to settle retail transactions almost instantly, 24/7, at negligible cost. CBDCs could slide into that infrastructure, cutting transaction fees and speeding up commerce. That could reduce economic friction and lead to productivity gains for the economy.
Some economists view CBDCs as a monetary-policy conduit, as well. Deposits of $1 million or more in CBDCs, for instance, might incur a 0.25% fee to a central bank, disincentivizing people and institutions from hoarding savings in a protracted slowdown. “It’s costly for the economy if wealthy people shift money into cash or equivalent securities,” says Dartmouth College economist Andrew Levin. “This would disincentivize that from happening.”
Digital currencies aren’t without controversy, though, and would need to overcome a host of technological issues, privacy concerns, and other hurdles. For one, they could make it easier for governments to spy on private-party transactions.
Anonymity would need strong safeguards for a CBDC to reach critical mass in North America or Europe. Chinese officials have said their CBDC will preserve privacy rights, but critics say otherwise. The country’s new CBDC could “strengthen its digital authoritarianism,” according to the Center for a New American Security, a think tank in Washington, D.C.
There are challenges for commercial banks, too. Central banks could compete with commercial banks for deposits, which would erode banks’ interest income on assets and raise their funding costs. Various proposals address those concerns, including compensating banks for services in CBDCs.
Deposit rates would have to be competitive so that central banks don’t siphon deposits. But even in a two-tier financial model, commercial banks could lose deposits, pushing them into less stable and higher-cost sources of funding in debt or equity markets.
More disconcerting for banks: They could be cut out of data streams and client relationships. Those loops are critical to selling financial services that can generate more revenue than lending. “CBDCs will pose more competition to the banking sector,” says Ahya. “It’s about the loss of data and fee income from financial services.”
Banks in the U.S., Europe, and Japan don’t face imminent threats, since regulators are going slow. As incumbents in the system, banks still have vast advantages and could use CBDCs as a means of cross-selling other services. Most of the advanced CBDC projects are for wholesale banking, like clearing and settlement, rather than consumer banking.
The ECB, for instance, has said it may limit consumer holdings to 3,000 euros, or about $3,600, in a rollout that may not kick off until 2025.
A timeline for a digital dollar hasn’t been revealed by the Fed and may take congressional action. More insights into the Fed’s thinking should be coming this summer: The Boston Fed is expected to release its findings on a prototype system. One compromise, rather than direct issuance, is “synthetic” CBDC—dollar-based stablecoins that are issued by banks or other companies, heavily regulated, and backed by reserves at a central bank.
Whatever they develop, central banks can’t afford to be sidelined as digital tokens blend into social-media, gaming, and e-commerce platforms—competing for a share of our wallets and minds. Imagine a future where we live in augmented reality, shopping, playing videogames, and meeting digital avatars of friends.
Will we even think in terms of dollars in these walled gardens? That future isn’t far off, says the economist Brunnermeier.
“Once we have these augmented realities, competition among currencies will be more pronounced,” he says. “Central banks have to be part of this game.”
Fed Warns Of Peril For Asset Prices As Investors Gorge On Risk
A rising appetite for risk across a variety of asset markets is stretching valuations and creating vulnerabilities in the U.S. financial system, the Federal Reserve said in its semi-annual financial stability report.
“Vulnerabilities associated with elevated risk appetite are rising,” Fed Governor Lael Brainard, the head of the Board’s financial stability committee, said in a statement accompanying the report released Thursday. “The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event.”
In this environment, prices may be vulnerable to “significant declines” should risk appetite fall, the Fed report noted.
Brainard and the report mentioned losses at banks stemming from dealings with Archegos Capital Management, and the governor called for “more granular, higher-frequency disclosures.”
“The Archegos event illustrates the limited visibility into hedge-fund exposures and serves as a reminder that available measures of hedge-fund leverage may not be capturing important risks,” she said.
The Managed Funds Association, which represents hedge funds, took issue with Brainard’s remarks.
“It is unfortunate policy makers incorrectly conflate hedge funds with unregulated entities like individuals and family offices,” Association President Bryan Corbett said in a statement. “Hedge funds are well regulated” by the Securities and Exchange Commission.
Near-zero interest rates and massive bond purchases, with the Fed buying $40 billion in mortgage-backed securities and $80 billion in Treasuries every month, have fueled a search for returns and helped buoy asset prices including those of risky investments such as speculative stocks, cryptocurrencies and high-yield debt. The Standard and Poor’s 500 stock index has risen 12% this year.
“The real story here is the tension — if not the glaring contradiction — of the Fed’s pursuit of quantitative easing, the aim of which is to lower long-term rates and encourage reach for yield, and their concern that people are indeed reaching for yield,” said George Selgin, a senior fellow at the Cato Institute in Washington, referring to the bond buying. “The Fed could certainly taper its QE activities to counter this risk-taking as the recovery continues.”
Spacs, Meme Stocks
“Indicators pointing to elevated risk appetite in equity markets in early 2021 include the episodes of high trading volumes and price volatility for so-called meme stocks — stocks that increased in trading volume after going viral on social media,” the report said. “Elevated equity issuance through SPACs also suggests a higher-than-typical appetite for risk among equity investors.”
Low rates are also impacting the real economy. Home prices are up 12% year over year amid high demand for property and scarce supply, while a boom in home remodeling has helped push lumber futures to record highs. The Bloomberg Commodity Index, which tracks everything from grains to natural gas and nickel, is up 19%.
Just About Everything Costs More At American Grocery Stores
The higher prices food makers have been warning about for months have hit U.S. grocery carts.
Seafood prices are up 18.7% on average in the 13-week period ended April 24, while baked goods like doughnut and rolls cost about 7.5% more than in the same period last year, new data from NielsenIQ show. In fact, 50 of the 52 categories tracked by the data provider are more expensive than a year ago, with only butter and milk holding essentially flat while everything around them skyrockets.
Rising commodity costs are partially behind the surging price tags, with the Bloomberg Commodity Spot Index — which tracks 23 raw materials — now at its highest level in almost a decade. Surging transport costs and supply chain disruptions are contributing, too, as is a continued bump in consumer demand as more Americans cook at home.
“Everyone is looking to offset higher transportation costs, higher labor costs and higher input costs. And that flows through the whole chain all the way to the consumer,” said Bloomberg Intelligence analyst Jennifer Bartashus. “Inflation expectations for 2021 are much higher than they’ve been in recent years.”
With demand so elevated during the pandemic, grocers have not had to discount as many items as they normally would have, said the chief executive officer of Albertsons Cos., which operates 2,277 supermarkets including chains like Safeway and Vons.
“When there’s a shortage in supply, it makes no sense to promote aggressively,” Vivek Sankaran said in an April 26 interview.
“That’s why you see inflation in some categories. It just makes no sense to play with price at this point.”
These higher food prices come at a time when U.S. gasoline prices are also rising, pinching everyday consumers.
“It has the prospects of being tough and getting tougher as the year progresses. There is some residual stimulus out there, but as that is used up or has been saved, it will increase the pressure on consumers in terms of just their regular budget,” Bartashus said.
Food inflation is also hitting restaurant chains. At Dine Brands Global Inc., parent company of Applebee’s and IHOP, packaging, pork and pancake mix prices are the big areas where prices are rising, CEO John Peyton said in a May 5 interview.
Chicken prices are also rising, with companies reporting surging demand and occasional outages as poultry supply runs low.
So far, Dine Brands hasn’t raised national menu prices, but it could happen later this year and franchisees can always elect to raise their own prices. “Commodity and labor costs have got upward pressure on them right now,” Peyton said.
For TGI Friday’s Inc., its pork prices that have been the biggest issue lately.
“Pork has been our biggest priority, primarily getting the rib product and the bacon products that we need. We’ve seen an increase in cost. Fortunately we have the supply that we need, but it is more expensive,” CEO Ray Blanchette said in an interview. “There’s been some supply chain issues that we’re now paying for.
Tin Prices Soar On Electronics Demand, Shipping Trouble
The metal has climbed 46% in 2021 and is approaching record highs.
High demand for consumer electronics and difficulties shipping metal out of Asia have created a shortage of tin, pushing prices for the metal close to records for the first time in a decade.
On the London Metal Exchange, the price of tin to be delivered in three months has soared 46% this year to $29,785 a metric ton, outstripping other metals such as copper and aluminum. Tin last fetched as much at the height of the run-up in metal markets in 2011, when prices crested at more than $33,000 a ton.
Tin’s advance is one of the biggest moves in commodity markets that have ripped higher, feeding expectations among investors that inflation will accelerate, at least temporarily.
Lofty commodity prices have acted as a brake on factories. Companies are looking to pass higher input costs through to consumers, some of whom are feeling the pinch. Worries about inflation have sent jitters through Wall Street, hurting stocks.
“Demand is wild across the board,” said Evan Morris, co-president of Nathan Trotter & Co., adding that he has never experienced such acute shortages of tin.
The Sadsburyville, Pa.-based manufacturer of solder wire and other tin products is racing to keep up with orders. Coronavirus has constrained supplies of raw metal coming out of Indonesia and elsewhere, while a snarl-up in container-shipping markets has led to weekslong delays in transporting tin from Southeast Asia and Latin America.
The market for tin—the most expensive of the major base metals—tumbled in 2019 when a downturn in semiconductor sales knocked demand. Prices took another leg lower when lockdowns and the closure of factories hit sales of industrial commodities in early 2020.
Fast forward a year and the market is “probably the most squeezed it’s ever been,” said Charles Swindon, managing director of U.K.-based RJH Trading Ltd.
Demand is strongest in the U.S., pushing prices on the ground as much as $3,000 a ton above where tin trades on the LME, according to Mr. Swindon. The high price “reflects genuine demand; otherwise people wouldn’t be paying these premiums,” he said.
Shares of mining companies are gaining from the jump in metals prices. BlackRock Inc.’s iShares MSCI Global Metals & Mining Producers exchange-traded fund has risen 34% this year.
Behind tin’s comeback is a surge in sales of consumer electronics such as laptops, cellphones and televisions during the pandemic.
Solder, the melted metal used to attach semiconductor chips to circuit boards and electronic devices, accounts for about half of global tin demand, said James Willoughby, analyst at the International Tin Association.
The value of world-wide semiconductor sales rose 3.6% in the first three months of 2021, compared with the previous quarter, and 17.8% from a year before, according to the Semiconductor Industry Association, a U.S. industry group.
The hot housing market is also aiding tin’s recovery. Tin, used to make certain plastics more resistant to heat, is benefiting from a rush to buy drainpipes and cladding for new homes.
Supplies are running low. Just 490 tons of refined tin were available in London Metal Exchange warehouses dotted around the world last week, with 840 more earmarked for withdrawal. That is just over half what was available at the end of 2020.
Metal in LME sheds is considered the source of last resort, so removals indicate shortages in the wider market, said Tom Mulqueen, an analyst at Amalgamated Metal Trading Ltd.
The rally is giving succor to aspiring tin miner Cornish Metals Inc.
Last month, the company drove a diamond-encrusted drill into the ground to search for copper and tin in the Gwennap district of Cornwall, southwest England, where copper was mined in the 1700s and 1800s.
To pay for the exploration, Cornish Metals listed its shares in London and raised £8.2 million, or the equivalent of $11.6 million, a deal that gained traction because of the upswing in prices, said Chief Executive Richard Williams.
Cornish Metals is weighing ways to raise more money to drain as much as 10 million cubic meters of water from South Crofty, a separate, disused tin mine a few miles down the road.
Tin prices are among the biggest gainers in a banner year for commodity markets.
High demand for consumer electronics and difficulties shipping metal out of Asia have created a shortage of tin, pushing prices for the metal close to records for the first time in a decade.
On the London Metal Exchange, the price of tin to be delivered in three months has soared 46% this year to $29,785 a metric ton, outstripping other metals such as copper and aluminum. Tin last fetched as much at the height of the run-up in metal markets in 2011, when prices crested at more than $33,000 a ton.
Tin’s advance is one of the biggest moves in commodity markets that have ripped higher, feeding expectations among investors that inflation will accelerate, at least temporarily.
Lofty commodity prices have acted as a brake on factories. Companies are looking to pass higher input costs through to consumers, some of whom are feeling the pinch. Worries about inflation have sent jitters through Wall Street, hurting stocks.
“Demand is wild across the board,” said Evan Morris, co-president of Nathan Trotter & Co., adding that he has never experienced such acute shortages of tin.
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The Sadsburyville, Pa.-based manufacturer of solder wire and other tin products is racing to keep up with orders. Coronavirus has constrained supplies of raw metal coming out of Indonesia and elsewhere, while a snarl-up in container-shipping markets has led to weekslong delays in transporting tin from Southeast Asia and Latin America.
The market for tin—the most expensive of the major base metals—tumbled in 2019 when a downturn in semiconductor sales knocked demand. Prices took another leg lower when lockdowns and the closure of factories hit sales of industrial commodities in early 2020.
Fast forward a year and the market is “probably the most squeezed it’s ever been,” said Charles Swindon, managing director of U.K.-based RJH Trading Ltd.
Demand is strongest in the U.S., pushing prices on the ground as much as $3,000 a ton above where tin trades on the LME, according to Mr. Swindon. The high price “reflects genuine demand; otherwise people wouldn’t be paying these premiums,” he said.
Shares of mining companies are gaining from the jump in metals prices. BlackRock Inc.’s iShares MSCI Global Metals & Mining Producers exchange-traded fund has risen 34% this year.
Behind tin’s comeback is a surge in sales of consumer electronics such as laptops, cellphones and televisions during the pandemic.
Solder, the melted metal used to attach semiconductor chips to circuit boards and electronic devices, accounts for about half of global tin demand, said James Willoughby, analyst at the International Tin Association.
The value of world-wide semiconductor sales rose 3.6% in the first three months of 2021, compared with the previous quarter, and 17.8% from a year before, according to the Semiconductor Industry Association, a U.S. industry group.
The hot housing market is also aiding tin’s recovery. Tin, used to make certain plastics more resistant to heat, is benefiting from a rush to buy drainpipes and cladding for new homes.
Supplies are running low. Just 490 tons of refined tin were available in London Metal Exchange warehouses dotted around the world last week, with 840 more earmarked for withdrawal. That is just over half what was available at the end of 2020.
Metal in LME sheds is considered the source of last resort, so removals indicate shortages in the wider market, said Tom Mulqueen, an analyst at Amalgamated Metal Trading Ltd.
The rally is giving succor to aspiring tin miner Cornish Metals Inc.
Last month, the company drove a diamond-encrusted drill into the ground to search for copper and tin in the Gwennap district of Cornwall, southwest England, where copper was mined in the 1700s and 1800s.
To pay for the exploration, Cornish Metals listed its shares in London and raised £8.2 million, or the equivalent of $11.6 million, a deal that gained traction because of the upswing in prices, said Chief Executive Richard Williams.
Cornish Metals is weighing ways to raise more money to drain as much as 10 million cubic meters of water from South Crofty, a separate, disused tin mine a few miles down the road.
Options include another equity raise or a private-equity backer, according to Mr. Williams.
Another factor feeding into a dearth of refined tin in the West is the monthslong shortage of shipping containers. Traders face delays and high prices to ship refined metal from Malaysia, Indonesia and Thailand, the biggest suppliers to buyers outside China.
In the spot freight market, the cost of a 40-foot container moving goods from Asia to the West Coast stood at $5,144 Friday, according to freight-booking platform Freightos, more than three times higher than at the start of 2020.
As World Runs Short Of Workers, A Boost For Wages—And Inflation
In the two largest economies, plunging birthrates and aging populations squeeze the labor supply.
The inflationary pressures now roiling the economy and markets will probably fade once the economy has fully reopened and the pandemic is in remission.
Yet beneath the surface some of the forces that have long kept inflation in check are starting to turn. Most important: demographics.
The world’s two largest economies have just reported that their population growth in the past decade was the slowest in generations, as people aged and birthrates plummeted.
Lower fertility initially boosts the labor supply by enabling more women to enter the workforce. But fertility has been falling for so long in the U.S. and China that those demographic dividends were spent long ago, and now they face the consequences: a diminished supply of workers.
The U.S. population grew 7% between 2010 and 2020, the slowest since the 1930s, according to decennial census results released last month. The age breakdown isn’t yet available, but a smaller sample by the Census Bureau and the Bureau of Labor Statistics shows that the working-age population—those ages 16 to 64—grew just 3.3%.
Because the share of those people working or looking for work has shrunk, the working-age labor force grew only 2%, and actually shrank last year. Some of those missing workers will return when the virus recedes, schools reopen and unemployment insurance becomes less generous. But many won’t: Baby boomer retirements have soared.
Reversing this move would require either a dramatic increase in births, which has eluded countries with more-family-friendly policies (and the labor force wouldn’t benefit for years), or immigration, which is politically hard.
The demographic squeeze is far more severe in China, which unlike the U.S. admits almost no immigrants and for years limited families to one child. On Tuesday, authorities announced that the population in China had grown just 5.4% in the past decade. The working-age population—those ages 15 to 59—shrank 5%, or roughly 45 million people.
When worker shortages began emerging over a decade ago, factories began moving to poorer inland provinces and then cheaper countries including Vietnam. In recent years some indicators suggest jobs are getting harder to fill, though the data might not be nationally representative.
Workers produce more than they consume while dependents—children and retirees—consume more than they produce, economists Charles Goodhart and Manoj Pradhan argue in their book “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival,” published last year.
Over the past three decades the integration of China and Eastern Europe into the global economy, the entry of baby boomers into the workforce and rising women’s participation effectively doubled the labor supply of advanced economies, putting downward pressure on costs and workers’ bargaining power.
That move is now reversing as dependents grow much more quickly than workers, and “dependents are inflationary,” Messrs. Goodhart and Pradhan write. A growing share of a shrinking labor force must be devoted to supporting the elderly: “Think of the one child policy in China, with one grandchild to four grandparents, two of whom could easily contract dementia.”
Aging creates numerous problems for economies long used to plentiful labor and low inflation. The elderly’s political clout makes it hard, even for authoritarian societies such as Russia, to raise the retirement age or trim pensions. Then-President Donald Trump broke with Republican orthodoxy by opposing reduced benefits for Social Security or Medicare.
President Biden has proposed lowering the Medicare retirement age to 60 from 65 and pouring more money into elder care. Such a move enhances quality of life, but it also adds to cost pressures because healthcare is notoriously resistant to labor-saving efficiency.
Workers nearing retirement are in their highest-saving years. As they retire, they draw down those savings. Young adults are marrying later, leaving fewer years to save. Corporations might have to invest more to compensate for shrinking workforces. All of this will chip away at the “global saving glut” that has held interest rates down in recent decades, Messrs. Goodhart and Pradhan argue.
Whether inflation actually accelerates is largely up to central banks. But shifting demographics could change their challenge, from fighting to keep inflation up in the face of deflationary forces, to keeping it down in the midst of inflationary forces.
Of course, numerous other factors are at work. Indeed, the world, in particular Japan, has been aging for a while without any obvious effect on inflation and interest rates.
Some studies have found that low-wage competition from China did hold down U.S. inflation, but outsourcing had basically peaked by the 2008-09 global financial crisis. Even the steep tariffs that the U.S. imposed on Chinese imports in 2018 and 2019 didn’t raise prices much.
One reason might be that private investment sank in the aftermath of the financial crisis, which was only partially offset by government borrowing. By contrast, investment has remained steady throughout the pandemic, and government borrowing has soared. As for Japan, Messrs. Goodhart and Pradhan argue that it began running out of workers when it could still outsource production to China. That is no longer an option.
China itself doesn’t plan to let aging change its high-saving, high-investment model, notes Andrew Batson of Gavekal Dragonomics, a research service. A recent paper by the People’s Bank of China acknowledges the demographic challenge but argued against letting saving and investment decline as a result: “Consumption is never a source of growth.…The high consumption rate of developed economies has historical reasons; once you switch, there’s no going back, so we should not take them as an example to learn from.”
Yet what matters for the world is whether Chinese saving and investment depress global inflation and interest rates. China is directing more of its investment inward while facing rising barriers to its exports as Western voters sour on globalization and China.
After decades of declining power, “labor has retaliated, not at the wage bargaining table, but in the voting booth,” write Messrs. Goodhart and Pradhan, adding that globalization “has been checked by populism, just at the time that demographic factors are swinging back to labor’s advantage.”
Inflation And Rising Bond Yields Will Hit the ECB’s Pain Point
Italy’s climbing debt burden leaves it more vulnerable than ever to higher borrowing costs. The ECB needs to step in.
Investors concerned about inflation rearing its capital-eroding head are demanding higher yields in the bond market. But this rise in government borrowing costs, at a time when nations have loaded up on debt to defend their virus-stricken economies, poses a challenge for the European Central Bank, with Italy particularly vulnerable to a financial squeeze.
Markets are anticipating that the combination of fiscal and monetary stimulus will finally stir consumer prices from their lengthy slumber. In the euro zone the five-year forward inflation swap, used by the ECB to gauge expectations, has recently climbed to 1.6%, its highest level in more than two years. This year’s average of 1.4% is the strongest since 2017’s 1.65%.
In response to this changing economic outlook, Italy’s 10-year borrowing cost has more than doubled in the past three months, surpassing 1% to reach its highest level in nine months. It’s climbed at twice the pace of benchmark German debt levels, which are themselves close to rising above zero for the first time in two years. France started paying to borrow for decade-long debt earlier this year.
The easy trade in Europe this year has been betting on a compression of the spread between Italy and Germany by owning the debt of the former — the euro zone’s most liquid and highest-yielding country — and being short that of the latter, which has the most negative-yielding bonds. That bet works brilliantly when yields are falling, but it swiftly unravels when the opposite occurs. A rapid repositioning by bond traders threatens to exacerbate Italy’s interest-rate woes.
Even at its current elevated level, Italy’s 10-year borrowing cost is well below the 2018-2019 average of 2.25%. Those were painful times for Europe’s third-largest economy and biggest debtor — and were supposed to be firmly in the rear-view mirror. Yet until the EU’s Recovery Fund cavalry turns up sometime later this year, Europe’s weakest link remains vulnerable.
It is totally within the ECB’s grasp to show it has Italian premier Mario Draghi’s back: The bank can step up its weekly bond purchases to help close the spreads or at least keep them contained.
ECB President Christine Lagarde promised at the March meeting to substantially increase the speed of bond buying, and repeated that pledge at April’s press conference. The next quarterly economic update on June 10 will involve an ill-timed review of the pandemic purchase program. The 500 billion-euro injection to increase the program to 1.85 trillion euros was only agreed to in December. But several governing council members want to call time on monetary stimulus before fiscal stimulus has even started, let alone begun to take effect.
To prevent the rise in yields getting out of hand, the ECB has got to accelerate its weekly bond buying to more than 20 billion euros. In the past week, the pace slipped again to 16.3 billion euros from 19 billion euros the week before, albeit reduced by large redemptions. That slippage risks re-igniting the debate about premature tapering that has been an unfortunate feature of ECB press conferences this year.
The central bank’s latest forward guidance has focused on ensuring what it opaquely calls “favorable financing conditions,” with much hullabaloo about a new “multi-faceted and holistic” approach. It is hard to decipher what this comprises, but for certain the critical element is underlying government borrowing costs.
The recent government bond rout is already filtering through to real-economy corporate financing. Some 80% of new investment-grade bonds sold this year by non-financial companies trade below their issue price, our Bloomberg News colleague Tasos Vassos reported on Friday. Investors burned by those price declines will demand higher yields on future sales.
The ECB needs to make sure the current market realignment does not get out of hand, especially when it has all the available tools to prevent it. In 2018, for example, the 10-year Italian yield jumped to 3.75% in October from 1.75% in May; a replay of that magnitude would be an epic disaster for the nation’s finances. Lagarde needs to swiftly display leadership akin to Draghi’s “whatever it takes” mantra.
Inflation Might Hold Back Dollar’s Rebound
The U.S. currency remains weak even as interest rates have climbed.
As interest rates have shot upward, the U.S. dollar’s continued weakness is something of a puzzle. Fear of rising inflation is partly to blame.
The accelerated pace of vaccinations and the passage of a large stimulus package have ignited hopes of a strong economic rebound in the U.S., driving Treasury yields sharply higher. At the same time, growth expectations for Europe have taken a hit as the EU’s vaccination drive has stumbled and the continent appears at risk of a devastating third pandemic wave.
Normally such a combination of factors would be a clear recipe for a stronger U.S. dollar, particularly as measured by the widely traded but narrow ICE Dollar Index, in which the euro carries a 57.6% weighting. And that index has in fact climbed 2.1% so far this year, yet it remains 6.4% below its year-earlier level. The broader WSJ Dollar Index is down 10.8% from a year ago.
That is surprising, especially since yields on 10-year Treasurys over the past year have climbed to 1.71%, from 1.25%. The yield gap with German 10-year government bonds has widened over the past year by 0.48 percentage point, which again should be positive for the dollar and the ICE dollar index in particular.
Along with rising growth expectations in the U.S. have come rising inflation expectations, though, especially since the Federal Reserve has pledged to let inflation run hotter than it normally would. This is negative for the dollar as it threatens to reduce its real-world purchasing power.
One market indication of rising inflation expectations are the yields on Treasury inflation-protected securities, or TIPS. 10-year TIPS now yield negative 0.58%. Comparing this with the yield on ordinary Treasurys implies the market is pricing in annual inflation of around 2.4% over the next decade. A year ago, this so-called “inflation compensation” priced into TIPS was just 0.7%.
Markets economist Simona Gambarini of Capital Economics points to the difference in yields between TIPS and similar inflation-linked bonds in Europe as a proxy for the real, inflation-adjusted yield gap. In contrast to the widening gap between ordinary U.S. and German government bonds over the past year, the yield gap between TIPS and comparable inflation-linked bonds in Germany has actually narrowed by 0.29 percentage point over the same period, though it has widened a bit in recent weeks. This helps explain the dollar’s weakness.
Of course Germany and even Europe aren’t the entire world. Another factor holding down the dollar is that many other economies are also seeing their prospects brighten. A strong U.S. recovery in itself should be good news for major exporters and commodity-producing nations, boosting the currencies of countries such as Australia, New Zealand and Norway, Ms. Gambarini says. None of these countries are reflected in the ICE dollar index, but they collectively make up around 10% of the WSJ dollar index. The Canadian dollar alone carries a 9% weighting on the ICE index and is up 1.7% against the dollar so far this year.
Inflation Starts to Hit Auto and Home Insurers
Key question is whether premium increases will be big enough amid chip shortage, scarcity of rental cars, higher building-material prices.
Investors hunting for signs of inflation pressure should keep an eye on something they might not usually think about: the cost of insuring a car or home.
Last year insurers were often lowering premiums for auto customers who were driving a lot less and therefore getting into fewer accidents. Now, as life in the U.S. begins to return to normal, consumers’ motor-vehicle insurance costs are again rising. The recent U.S. consumer-price index update had that component up 6.1% in April from a year earlier, ending a long string of decreases and jumping the most since 2018.
The question for insurers is whether premium increases will be big enough. Part of the cost of covering a claim to repair or replace a car or home is under pressure. Factors include the global chip shortage, the scarcity of rental cars and the increased price of lumber and other building materials. The consumer-price-index measure of vehicle-repair costs has been on the rise.
At the same time, it is unclear how quickly people will return to their old driving habits and what that will do to accident frequency. Perhaps they still aren’t driving to work as often. But are they taking a lot more road trips?
Progressive said earlier this month it was monitoring such things as the pace of people returning to the office, lumber prices and the chip shortage. The company’s April underlying ratio of accident-year, noncatastrophe loss and loss-adjustment expense to net earned premium was about 70%, higher than about 67% during the prior month.
There are some long-standing trends that could come to the foreground for insurers as the pandemic wanes. Fitch Ratings earlier this month noted long-term challenges in the severity of losses for commercial auto coverage, such as more sophisticated technology and components within vehicles that make repairs and replacement more costly. Insurers have also been trying to keep up with another kind of inflation, the so-called social inflation marked by higher jury awards.
Some of these price increases might be only transitory. Historically, cost surges can still sometimes hit businesses such as homeowners insurance. Ryan Tunis of Autonomous Research noted that a 2009 jump in ratios of losses and expenses to premiums for home policies was largely attributable to a jump in construction costs. For some types of policies, such as home and auto, sustained inflation can be priced into renewal terms. There are, however, also businesses for which premiums collected today have to cover years of possible future claims. If persistent wage inflation occurs, for example, it could hit commercial policies such as workers’ compensation, according to Mr. Tunis.
Meanwhile, coming Atlantic storm season activity is expected to be above average, according to forecasts by Colorado State University hurricane researchers.
So even as premium rates rise, there could still be pressure on profitability from increases in both frequency and severity, particularly if rebuilding costs are unusually high.
U.S. property-and-casualty insurance stocks largely did better than banks and many other financials in 2020, though banks have mostly surged ahead this year. Like banks, insurers would also benefit from higher yields in their investment portfolios, and generally rising prices could help extend the so-called hard market of higher policy pricing. But they might be in for a bumpier ride for now.
U.S. Household Spending Growth Moderates; Core Prices Jump
U.S. personal spending rose at a steady, yet moderate pace in April after a stimulus-fueled binge a month earlier.
The reading is consistent with sustained growth in the biggest part of the economy and partly reflects faster inflation.
Purchases of goods and services increased 0.5% following an upwardly revised 4.7% jump in March that was the biggest since June, Commerce Department figures showed Friday.
The personal consumption expenditures core price gauge, which excludes food and fuel, increased 0.7%, exceeding expectations and the biggest monthly advance since October 2001.
The figures indicate that even as the impact of a third round of stimulus checks wanes, consumers have the wherewithal to continue spending at a solid pace and deliver more support for economic growth.
The outsize March spending gain provided a robust hand-off to growth in the second quarter. Combined with the April increase, the figures help explain why economists currently forecast the economy will accelerate to a 9.4% annualized pace after a 6.4% rate in the first quarter.
Estimates in a Bloomberg survey of economists called for a 0.5% increase in personal spending and a 0.6% pickup in the core PCE price gauge. U.S. stocks rose in early trading, Treasuries were steady and the dollar strengthened.
In a separate report Friday, the U.S. merchandise trade deficit unexpectedly narrowed in April as exports climbed and imports fell from a record high.
The overall PCE index rose 0.6% in April for a second month. Adjusting for the increase in inflation, spending decreased 0.1% in April after an upwardly revised 4.1% increase a month earlier. Goods outlays declined 1.3%, while spending on services rose 0.6%.
Incomes dropped 13.1% after surging 20.9% in March when many Americans received another round of federal stimulus checks.
The April data showed transfer receipts that include stimulus payments and unemployment aid declined from a month earlier. That figure will likely fall further in the coming months as some states phase out federal jobless programs and the last stimulus checks get distributed.
The good news is that wages and salaries increased 1% for a second month. The personal savings rate fell to 14.9%, and disposable incomes, which exclude taxes and are adjusted for inflation declined 15.1% in April.
The core price index jumped 3.1% from April 2020. the largest increase since July 1992. The PCE price index — which the Federal Reserve officially uses for its inflation target — rose 3.6% from a year earlier.
The University of Michigan’s final May consumer sentiment figures on Friday showed respondents expect an inflation rate of 4.6% in the coming year, the highest in a decade.
However, the year-over-year inflation metrics are being distorted by so-called base effects. Because of the very weak inflation prints at the start of the pandemic, annual increases in the price metrics appear larger than they would typically.
Concerns about inflation have been hotly debated among politicians, economists and investors in recent months, with some arguing price increases are transitory and others worrying about elevated costs in the longer-term, especially with President Joe Biden’s plans for trillions in government spending in the coming decade.
In a series of speeches this week, some Fed officials pushed back against the threat that a spike in price pressures will prove lasting as the U.S. economy reopens.
“A very important part of inflation dynamics is longer-term inflation expectations and those have been extremely well anchored, implying that if we saw some development pushing inflation up I wouldn’t expect that to get embedded in the ongoing inflation rate,” Fed Governor Lael Brainard said Monday.
How To Know When Inflation Is Here To Stay
Keep an eye on skills shortages, consumers’ wallets and the market’s expectations.
Inflation is here already, and in the long run there is a lot of upward pressure on prices. But between now and then lies a big question for investors and the economy: Is the Federal Reserve right to think that the price rises we’re seeing now are temporary and will abate by next year?
Some at the Fed are already having vague doubts, starting to talk about when to discuss removing some of their extraordinary stimulus even as they continue to push the idea that inflation is likely to fall back of its own accord.
The argument that inflation is temporary is simple. Consumer demand has been boosted massively by stimulus and the reopening release of pent-up demand. Supply is unable to keep up thanks to inventories and capabilities run down when demand collapsed during lockdown, workers unwilling to return to work and the overhang of Covid-19 restrictions on production.
As a result, there are some extraordinary price ramps in narrow areas, such as used cars, that are pushing up headline numbers. The resulting price rises will abate once spare cash is spent and business is back to normal.
The difficulty is how to test whether this is right, because many of the usual gauges are being mucked up by the scale of the post-pandemic rebound. There are three broad areas to watch: the labor force, consumer demand and inflation expectations.
Workers can embed inflation through pay raises. There aren’t enough workers, so wages go up. Those workers have more money to spend, so prices of goods and services rise. The workers then demand pay raises, and on and on.
There is plenty of anecdotal evidence that pay is going up, especially for workers at the bottom of the jobs ladder. With a record number of vacancies, businesses report that they are raising pay and offering special bonuses for hiring, and several very large companies, including Amazon and McDonald’s, have increased wages amid a shortage of workers.
The National Federation of Independent Business found that the top overall concern of small-business owners in both March and April was labor quality, at a time when they are hiring furiously. Similarly, the Richmond Fed’s manufacturing survey in May showed by far the biggest skills shortages since it began asking about them in 2010.
But is this permanent? The inflation case is that the pool of workers no longer matches the skills employers need, and that wage rises at the bottom will filter up as more senior employees demand a raise to maintain their pay premium. The second part of this seems plausible, but the first is harder to understand.
Sure, lockdowns accelerated online adoption and perhaps encouraged older workers to retire, but has the economy really changed that much?
More likely is that the shortage of workers is driven by a temporary combination of Covid-19 fear and higher unemployment benefits making work less appealing, with some parents having child-care problems while schools are closed.
Fear will fade with vaccine deployment, extra federal benefits expire in September and schools will reopen. Come September, the 9.8 million unemployed and the 8.1 million job vacancies might match up, and the skills shortages and accompanying wage pressure go away.
We will find out for sure only in September; if some unemployed people have been choosing not to work, or caring for children, they will surely be eager to take jobs once benefits fall and all schools reopen.
Meanwhile, watch the jobs numbers for the Republican states that have chosen to cut benefits early to see if more people return to work. In September, look to surveys such as the NFIB and Richmond Fed for confirmation that skills shortages are easing, and keep listening for anything companies say about margins, as they grapple with whether to absorb higher wages or pass them through to customers.
Consumers came out of lockdown flush with cash, and have been spending frantically since shops, bars and leisure activities reopened. The survey of purchasing managers by IHS Markit showed new orders across the economy at the highest on record in May, and everything is booming.
It is unprecedented for household income to improve in a recession the way it did last year, so we should be humble when predicting what will happen next. One possibility is that households spend some of their savings but continue to save more than before in case of future trouble, while higher prices make people think twice about splashing out. In that case, the current demand surge would sputter and die away.
Another possibility is that consumers decide this is a rerun of the Roaring ’20s, and they want to party, spending down the entire savings pile; add in wage hikes and they will have even more to spend.
If this happens, demand could stay high for a long time, keeping up the pressure on supply and wages. Add in companies investing to try to catch up with demand and the conditions would be in place for a boom, with inflation continuing unless productivity improved or the workforce expanded.
Watch consumer spending and saving to gauge the mood, and corporate investment as a rough-and-ready proxy for future productivity.
Inflation expectations can become self-fulfilling, and are watched closely by the Fed. One-year consumer inflation expectations reached 4.6% in May, according to the University of Michigan survey, the highest since the China commodity boom of 2011.
However, long-run expectations of 3% are still only the highest since 2013, and unlikely to bother the Fed much, while the Treasury market’s long-term break-even inflation rate remains close to the Fed’s target of 2%. These, along with economists’ forecasts, should be watched closely. If expectations stop being anchored to the Fed’s target, policy makers will worry a lot.
U.S. Manufacturers Blame Tariffs For Swelling Inflation
Some economists differ, saying removing tariffs on metal, lumber won’t mean big drop in prices.
Economists and policy makers are debating whether stimulus spending and easy monetary policy are fueling inflation. Many businesses say there is another culprit that should share the blame: import tariffs.
The Trump administration implemented tariffs on products including lumber, steel and semiconductors to shield American companies from a glut of cheap imported products from China and other countries.
The tariffs have long been opposed by U.S. companies that import the goods and pay the levies. They are making a new push for the Biden administration to lift them, on grounds that tariffs contribute to rising prices and product shortages that are accompanying the post-pandemic recovery.
“I have had 15 price increases from my primary steel supplier since September,” said Scott Buehrer, president of B. Walter & Co., a Wabash, Ind., maker of fabricated metal products. “What’s the justification for these tariffs when you have sky-high steel prices?”
Some economists say the tariffs have had only muted effects on prices and that their removal won’t do much to ease the price pressure.
Mr. Buehrer’s company was among more than 300 manufacturers that wrote to Mr. Biden on May 6 asking him to immediately terminate 25% tariffs on steel and 10% levies on aluminum. The Biden administration has said it is reviewing the tariff policy but has no immediate plans to lift the tariffs.
The manufacturers say the tariffs make their companies less competitive at a time when U.S. buyers, facing red-hot domestic demand, are paying 40% more for some steel products than their European peers.
Mr. Buehrer said he has cut his payroll by 10% to reduce costs as the prices of rolled steel nearly tripled since last fall. But labor unions and the steel industry are urging Mr. Biden to keep the metal tariffs in place, saying in a May 19 letter that the policy has enabled the industry to “restart idle mills, rehire laid-off workers and invest in the future.”
“The tariffs have been in place since 2018 and there has been no inflationary pressure since then,“ said Roy Houseman, legislative director at United Steelworkers. “The U.S. has put trillions of dollars of stimulus in the economy. That is going to impart some inflationary pressure.”
Another industry wrestling with soaring prices is home-building.
Futures contracts of lumber in May reached more than $1,600 per thousand board feet—a record that is more than four times the typical price this time of year. The National Association of Home Builders estimates the higher lumber prices have added $36,000 to the price of a typical single-family home.
“It doesn’t make any economic sense to be taxing things when you don’t have sufficient domestic supply,” said Robert Dietz, NAHB’s chief economist. “Appliances, washing machines, literally the nuts and bolts that go into making a home—screws and nails—are subject to some of the metal tariffs.”
Home builders and lawmakers have pressed Mr. Biden to eliminate tariffs imposed in 2017 on Canadian softwood lumber, part of a decadeslong disagreement between U.S. and Canadian lumber producers.
Instead of removing the duty, the Commerce Department issued a preliminary decision May 21 to double the levy to 18%, concluding that Canadian imports are heavily subsidized. The tariffs will remain at the current 9% until a final decision on the proposed increase is made before November, a Commerce Department official said.
To provide relief from Trump-era tariffs on a broader range of Chinese imports, a bipartisan group of 40 U.S. senators in April asked the Biden administration to restart a process to grant importers exclusions for more than 2,000 items ranging from pillows to auto parts. The exclusion process, introduced by the Trump administration, expired in December but hasn’t been renewed.
When the Trump administration’s tariffs first went into effect, some economists warned they could spur inflation. But there appears to be a consensus that the impact has been muted.
“Given that the tariffs didn’t have a big impact on consumer prices in the first place, I probably wouldn’t expect their removal to result in significant downward pressure either,” said Andrew Hunter, economist for Capital Economics, a research firm.
The muted impact is partly because tariffs only affect imports, which typically make up a relatively small share of the domestic market. For steel, imports represent roughly one-third of the total U.S. demand. And the share of the taxed imports is even smaller as the largest exporters to the U.S.—Canada, Brazil and Mexico—are exempted.
Import prices of the goods subject to tariffs did rise initially. But many importers absorbed much of the increases, rather than pass the full increase on to consumers. Meanwhile, the prices of many goods not subject to the tariffs were declining, keeping the overall inflation rate low.
David Weinstein, a Columbia University economist, says tariffs may actually lower prices over the long term.
Mr. Weinstein and his colleagues examined changes in financial markets’ inflation expectations based on bond-market yields around the time of 11 new tariff announcements by the U.S. and China between 2018 and 2019.
To their surprise, he said, they found that the events lowered inflationary expectations so that prices were expected to be roughly 1 percentage point lower five years later and 1.3 points lower 10 years later. Stock prices also fell.
“What the markets are predicting, and our data is suggesting, is that the trade war will have negative impacts on productivity,” he said, referring to tariffs’ hit to companies’ operations. “When you hold down productivity, you’ll have really big impacts down the road on the success of your economy, and prices as well.”
The U.S. Trade Representative’s Office, which is conducting a review of U.S. tariff policy, is studying whether easing tariffs, among other factors, could relieve the supply shortage for lumber and other products, Cecilia Rouse, chair of the White House Council of Economic Advisers, said during a May 18 briefing.
She added, however, trade policy is a “much bigger issue” than short-term market gyrations and that it needs to be worked out in the context of Washington’s global policy.
Investors’ Inflation Bet Loses Some Steam
A key measure of inflation expectations has slipped in recent days, stirring debate over whether it has peaked.
A key measure of investors’ inflation expectations has slipped in recent days, stirring debate over whether it has finally peaked after this year’s near-relentless climb.
As of Wednesday, the gauge known as the 10-year break-even rate suggested that the consumer-price index will rise by an annual average of 2.47% over the next decade, according to Tradeweb. That was up from 2.01% at the end of last year, but down from its recent high of 2.57% on May 12.
The ups and down of the break-even rate have come under scrutiny in recent months as investors have grown increasingly concerned about inflation. A leveling off of or decline in the rate will cheer those who have worried that accelerating inflation could threaten investors’ portfolios in a way it hasn’t for decades. But it may also reflect expectations for tighter monetary policies from the Fed, which could drag on riskier assets like stocks.
Two assets determine the break-even rate: nominal U.S. Treasurys and Treasury inflation-protected securities, or TIPS, which increase their payouts as the consumer-price index rises. When investors buy TIPS, the yields on the securities are typically lower than nominal Treasurys of the same maturity. That difference is called the break-even rate because holders of TIPS can ultimately earn the same return as holders of nominal Treasurys if average annual CPI inflation matches that gap over the life of the bonds.
As of Wednesday, the yield on the benchmark 10-year U.S. Treasury note was 1.591%, while the yield on the 10-year TIPS was around minus 0.877%.
Several factors have lifted the break-even rate this year to its highest level since 2013. They include a vaccine-fueled economic recovery, massive amounts of government spending and consistent messaging from the Federal Reserve that it will take a patient approach to tightening monetary policy.
In recent weeks, however, some Fed officials have opened the door to talking about scaling back the central bank’s $120 billion a month purchases of U.S. Treasurys and mortgage-backed securities. That is widely seen as the first step in tightening monetary policy, and a precursor to higher short-term interest rates.
Some investors and analysts also said the break-even rate’s decline may reflect investors booking profits after crowding into bets on its rise.
“The little bit of a pullback may be reflecting a combination of some belief that it maybe has run too far as well as the fact that perhaps the Fed is going to put a little bit of a break on inflation expectations,” said Steven Oh, global head of credit and fixed income at PineBridge Investments.
Any shift in Fed policy would start from a position of unusual lenience. Last year, officials announced a new policy framework, stating explicitly that they would like inflation to spend a period of time above their 2% annual target to make up for the extended period it has spent below that threshold. The Labor Department reported last month that CPI rose 4.2% in April from a year earlier, though that number was inflated by comparisons to deeply depressed prices from the early days of the pandemic.
Even as the economy has picked up momentum, Fed Chairman Jerome Powell has repeatedly emphasized the distance it needs to travel to return to its pre-pandemic levels. After the Fed’s last policy meeting in late April, he insisted it was too soon to discuss tapering the central bank’s asset purchases, given the current state of the economy.
Minutes from the Fed’s April meeting, however, revealed that “a number of participants” had said that “it might be appropriate at some point in upcoming meetings” to begin discussing tapering if the economy continues to improve.
Reducing bond purchases could cool economic activity by increasing yields on nominal Treasurys—and therefore interest rates across the economy. At the same time, tapering could cause a larger increase in TIPS yields than nominal yields. That is because the Fed has been buying a disproportionately large amount of TIPS as part of its asset purchase program.
Even after a recent adjustment, the Fed is poised to absorb an amount of TIPS equivalent to more than 40% of those issued this year, according to BofA Global Research, compared with about 20% of nominal Treasurys.
Michael Lorizio, a senior trader at Manulife Investment Management, said he “would take the recent peaks [in break-even rates] as pretty firm resistance levels” given how high the rates have already climbed.
Some investors and analysts have noted parallels between the current moment and the so-called taper tantrum of 2013. In that episode, the 10-year break-even rate dropped from around 2.55% to below 2% after then-Fed Chairman Ben Bernanke brought up the possibility of scaling back bond purchases introduced in the wake of the 2008-09 financial crisis.
“It’s May, 10y break-even is at 2.55%: must be time for ill-timed taper talk; first 2013, now 2021,” BofA securitized products strategists Chris Flanagan and Graham Voss wrote in a May report.
The analysts, though, added that they don’t expect a “similar blunder from Powell” and predicted that the 10-year break-even rate will eventually “reach at least 2.75%-3.0%.”
U.S. Inflation Is Highest In 13 Years As Prices Surge 5%
The rapid rise in consumer prices in May reflected a surge in demand and shortages of labor and materials.
The U.S. economy’s rebound from the pandemic is driving the biggest surge in inflation in nearly 13 years, with consumer prices rising in May by 5% from a year ago.
The Labor Department said last month’s increase in the consumer-price index was the largest since August 2008, when the reading rose 5.4%. The core-price index, which excludes the often-volatile categories of food and energy, jumped 3.8% in May from the year before—the largest increase for that reading since June 1992.
Consumers are seeing higher prices for many of their purchases, particularly big-ticket items such as vehicles. Prices for used cars and trucks leapt 7.3% from the previous month, driving one-third of the rise in the overall index. The indexes for furniture, airline fares and apparel also rose sharply in May.
A separate reading showed the U.S. labor market continued to heal from the pandemic, with initial claims for unemployment benefits falling to another pandemic low.
Stocks edged higher on the inflation and labor market news.
May’s jump in prices extends a trend that accelerated this spring amid widespread Covid-19 vaccinations, relaxed business restrictions, trillions of dollars in federal pandemic relief programs and ample household savings—all of which have stoked demand for Americans to spend and travel more.
Overall prices jumped at a 9.7% annualized rate over the three months ended in May. On a month-to-month basis, overall prices rose a seasonally adjusted 0.6% and core prices rose 0.7%.
The annual inflation measurements are being boosted by comparisons with figures from last year during pandemic-related lockdowns, when prices plummeted because of collapsing demand for many goods and services. This so-called base effect is expected to push up inflation readings significantly in May and June, dwindling into the fall.
Compared with two years ago, overall prices rose a more muted 2.5% in May.
Gus Faucher, chief economist at PNC Financial Services Group, said that sharp rises continue to be concentrated in parts of the economy that were most whipsawed by the pandemic—in prices for used cars, airfares and hotel stays, for example.
“That suggests that this is part of the dislocation from the reopening, and I would expect that…inflation will settle down later this year,” Mr. Faucher said. “When you take a step back and look broadly at inflation throughout the economy, there are lots of areas where prices move very slowly, and it’s going to take a lot to get a sustained acceleration beyond these temporary factors.”
Prices for new vehicles have soared because of a computer-chip shortage that has crimped car production. That, in turn, has bolstered prices for used autos. Rental-car prices have soared because companies sold their fleets when demand collapsed along with travel during the pandemic. Airfares and hotel-room rates are rebounding as consumers start traveling again.
Policy makers are watching May’s reading to gauge the magnitude of what many expect to be several months of stronger inflation after a year of very weak price pressures during the worst of the pandemic. Whether the pickup in inflation proves temporary is a key question for the U.S. economy and financial markets as the Biden administration, Congress and the Federal Reserve continue to support the economy with fiscal and monetary policy measures.
The Fed expects the inflation rate to rise temporarily this year. A sustained, large increase in inflation could compel the central bank to tighten its easy-money policies earlier than it had planned, or to react more aggressively later, to achieve its 2% average inflation goal.
More companies also have started passing on to consumers the higher costs they are facing for raw materials and wages.
Food makers said their costs are climbing at an alarming rate, prompting them to raise some prices.
“The inflation pressure we’re seeing is significant,” General Mills Inc. Chief Executive Jeff Harmening said at a recent investor conference. “It’s probably higher than we’ve seen in the last decade.”
He and his peers point to transportation, commodity and labor costs all increasing at the same time. They expect the trend to continue for at least the rest of this year. As a result, General Mills, Campbell Soup Co. , Unilever PLC, J.M. Smucker Co. and other big food companies are raising prices. Some increases are already visible on supermarket shelves, and more are coming this summer.
The upswing in prices reflects robust consumer demand, the main driver of the economic rebound. U.S. gross domestic product rose 6.4% at a seasonally adjusted annual rate in the first quarter. Economists surveyed by the Journal in April forecast the economy to grow at an 8.1% annual rate in the second quarter, leaving it poised for its best year since the early 1980s.
“I’d say stronger service inflation right now is actually a good thing,” said Michael Gapen, managing director and chief U.S. economist for Barclays. “No one ever wants to think higher prices are good. But in this case I think it’s reflective of healing.”
Stronger demand has spurred employers to try to hire more workers, but many businesses are raising wages as they struggle to hire people. Job openings reached 9.3 million in April, the highest number since records began in 2000, as the gap widened between open positions and workers taking the roles.
Chipotle Mexican Grill Inc. recently raised its menu prices by roughly 4% across many markets to help cover the costs of wage increases as well as higher commodity prices, Jack Hartung, chief financial officer, said at an investor conference earlier this week.
Some 48% of small businesses indicated that they raised average selling prices in May, the highest share since 1981, according to a survey conducted by the National Federation of Independent Business, a trade association.
Mr. Gapen of Barclays said higher wages won’t necessarily translate to faster wage growth of the sort that could accelerate inflation. “What will be difficult to understand is if this is a one-off issue as we come out of the pandemic,” he said.
The unique dynamics of reopening an economy that is powered by consumer spending are at play, Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, said. Consumers are willing to shell out more than they might be normally, thanks to a year of being cooped up at home and the extra savings many households have amassed.
“That type of price increase won’t be with us next year because consumers will balk at it. We may even see prices revert back to a lower level,” she said, referring to the rise in the car-rental price index, which surged nearly 110% from May 2020. “There’s only so much time people are going to be willing to say, ‘OK, I’ll pay a little more. I’ve gotten government assistance, and I’ve built up savings. I haven’t been out in a while. Whatever it takes, I’ll pay for it.’”
Lumber Prices Post Biggest–Ever Weekly Drop With Buyers Balking
Lumber futures posted their biggest-ever weekly loss, extending a tumble from all-time highs reached last month as sawmills ramp up output and buyers hold off on purchases.
Prices in Chicago fell 18% this week, the biggest decline for most-active futures in records going back to 1986. Lumber has has now dropped almost 40% from the record high reached on May 10.
Sawmills appear to be catching up with the rampant homebuilding demand in North America that fueled a months-long rally, bringing some relief to a market beset by supply shortages and price surges. Buyers are balking at still historically elevated prices and awaiting additional supplies, setting off a cascading sell-off, analysts said.
“Activity yesterday was brisk to start, turned lethargic and ended quite subdued,” William Giguere, who buys and sells eastern spruce with mills for Sherwood Lumber in Massachusetts, said in a note Friday. “There was plenty of lumber available from the mills and enough ambition to sell. Missing was the sense of urgency from buyers.”
Many buyers only purchased if necessary, generally staying on the sidelines, CIBC analyst Hamir Patel said Friday, citing an assessment from Random Lengths. The closely watched trade publication reported further declines in several wood products that trade on the cash market, and pointed to an abundance of mill offerings, Patel said.
U.S. lumber production has responded to the price rally by ramping up output by 5% over the past 12 months with another expected increase of 5%, or roughly 1 billion board feet, according to Domain Timber Advisors LLC, a subsidiary of Domain Capital Group, in Atlanta, Georgia.
Resolute Forest Products Inc. is spending $50 million to increase its lumber production, the company said Thursday. West Fraser Timber Co., the world’s biggest producer, said recently that it’s expanding capacity at five U.S. mills, while rival Canfor Corp. has said it will invest around $160 million in a new sawmill in Louisiana.
Still, while lumber prices may finally be pulling back from stratospheric highs, don’t look for a return to pre-pandemic levels any time soon, according to BMO Capital Markets.
“‘Nosebleed’ prices won’t last, but strong demand, a limited supply response and a rising cost curve all point to above-trend prices for at least the next 12-24 months,” BMO analyst Mark Wilde said in a note.
Lumber futures slid 5.6% in Chicago to $1,059.20 per 1,000 board feet on Friday. Prior to the rally that started in mid-2020, lumber futures traded mostly within the range of $200 to $600 since 1992.
With strong U.S. home building expected to last for several years, lumber prices will likely remain above $500 per 1,000 board feet for the next five to eight years, said Scott Reaves, forest operations director at Domain Timber Advisors.
“We’re at a new normal,” Reaves said in a phone interview. “We’re going to see this sustained level of housing demand and a new normal for a pricing floor in lumber.”
Breakdown Of Price Rises Not In Line With Enduring Inflation Surge, Says Unicredit’s Vernazza
It’s a somewhat different story for car rentals, where acute supply shortages have caused prices to surge, while spending in the sector remains well below pre-pandemic levels because of limited supply, he said. For used cars, the combination of a switch away from public transport by commuters and a global shortage of semiconductors for new cars has pushed up both demand and prices.
What’s important to note, Vernazza said, is that since higher inflation is largely explained by the reopening of the economy and supply shortages, it’s likely to prove temporary as the direct effects of the pandemic fade and supply adjusts to meet demand.
But what would a more enduring inflation threat look like?
In that case, most of the items would occupy the upper-right quadrant of the chart, reflecting what economists refer to as “demand-pull inflation,” Vernazza said. To date, “this is clearly not the case,” the economist wrote.
While inflation jitters rattled financial markets as recently as last month, investor concerns have appeared to wane. Treasurys rallied Thursday, despite another hotter-than-expected consumer-price index reading, sending the yield on the 10-year Treasury note, 1.464% below 1.45%.
Higher inflation is typically seen as bad news for bonds, eroding the value of the interest payments delivered to holders. Stocks rallied Thursday, with the S&P 500 edging to a record close on Thursday, while the Dow Jones Industrial Average DJIA, remains not far off its all-time high and rallying tech shares, which are more sensitive to interest rates, pushed the Nasdaq Composite higher.
The Federal Reserve holds a policy meeting next week. While Fed officials have largely stuck to their view that inflation pressures will prove “transitory,” several have also said it’s time to begin thinking about when it would be appropriate to discuss pulling back on asset purchases at the center of its extraordinary monetary policy efforts to support the economy and heal the labor market.
And some economists caution that signs of inflationary pressures in more cyclical segments of the economy are beginning to emerge.
“Both rent and owners’ equivalent rent have staged a clear turnaround over recent months, and food-away-from-home prices surged by 0.6%,” said Michael Pearce, senior U.S. economist at Capital Economics, in a note. “It is no coincidence that rents and restaurant prices are rising more rapidly when wage growth is also accelerating.”
Pearce said a continued surge in job openings shows that worker shortages “are real and intensifying.”
“The recent strength of inflation and signs of labor shortages could prompt a handful of hawkish regional Fed presidents to bring forward their projections for rate increases and strengthen calls for tapering asset purchases sooner rather than later at next week’s FOMC meeting,” he wrote. “But we suspect the majority on the committee will stick to the ‘largely transitory’ language and instead emphasize the yawning shortfall in employment from pre-pandemic levels.”
Lumber Prices Are Falling Fast, Turning Hoarders Into Sellers
Prices have dropped from record highs, spurred by the economic reopening and potentially pointing to an eventual return to normalcy.
Lumber prices are falling back to earth.
Futures for July delivery ended Monday at $996.20 per thousand board feet, down 42% from the record of $1,711.20 reached in early May. Futures have declined 14 of the past 15 trading days, the last two by the most allowed by exchange rules.
Cash lumber prices are also crashing. Pricing service Random Lengths said Friday that its framing composite index, which tracks on-the-spot sales, dropped $122 to $1,324, its biggest ever weekly decline. The pullback came just six weeks after the index rose $124 during the first week of May, its most on record. Random Lengths described a chaotic rout in which sawmill managers struggled to provide customers with price quotes.
Economists and investors have wondered if sky-high prices for wood products would doom the booming housing market.
Builders raised home prices and many stopped selling houses before the studs were installed, lest they misjudge costs and sell too cheaply. Lumber became central to the inflation debate: whether a period of runaway inflation was afoot or high prices were temporary shocks that would ease as the economy moved further from lockdown.
The rapid decline suggests a bubble that has burst and the question now is how low lumber prices will fall. Even after tumbling, lumber futures remain nearly three times what is typical for this time of year.
Lumber producers and traders expect that prices will remain relatively high due to the strong housing market, but that the supply bottlenecks and frenzied buying that characterized the economy’s reopening and sent prices to multiples of the old all-time highs are winding down.
During the run up, wood was hoarded by builders, retailers and others worried about running out of material during a construction season set into overdrive by historically low mortgage rates and federal stimulus payments.
“Everyone was buying more than they needed,” said Mike Wisnefski, a former lumber trader and chief executive of online marketplace MaterialsXchange. “There was this fear of lack of availability.”
Now the market is being flooded by what Mr. Wisnefski calls shadow inventory as businesses that are normally big buyers, such as home builders and companies that prefabricate the trusses that hold up roofs and floors, sell from their own stockpiles.
The Commodities Boom Is Luring Criminals To Make Bigger And Bolder Scores
The pandemic, soaring prices, and economic pain have combined to create perfect conditions for thieves and fraudsters.
Sergeant Tosha Ternes spends most of her time at the Saskatoon Police Service investigating cases of breaking and entering. In recent months her department has seen a “drastic” increase in one type of crime: lumber theft from construction sites.
“Everything’s just lying there, kind of like a free-for-all,” Ternes says from the Saskatchewan city in Canada’s prairie region. “Some sites have been hit two, three, four times.”
Theft of commodities such as lumber, metals, and food crops is nothing new. Yet the combination of soaring prices, the coronavirus pandemic, and the hit to economies has created an unusually fertile ground for criminals.
Statistics are hard to come by because authorities use different data and much of it is from before the pandemic took hold. But interviews with experts, law enforcement agencies, and victims paint a picture of a spike in criminal activity as the jump in commodity prices fuels talk of another “supercycle” like the one in the first decade of the century.
In Chile, where the price of copper is tracked by bankers and taxi drivers alike because of its economic importance, gangs target freshly smelted stacks of the metal as it travels on rail cars. When thieves strike, police dressed in “war gear” give chase in patrol cars, says one officer in the Antofagasta region, which is home to some of the world’s biggest copper mines.
There are reports out of Germany, the U.K., and the U.S. of catalytic converters in cars being harvested for their precious metals. In Nigeria, which like many developing countries is suffering from runaway inflation in food prices, some farmers complain that thieves are targeting crops.
“They used to steal in small quantities before,” says Johnson Akinwunmi, a farmer in Ondo state who grows cocoa and cassava. “But now it’s been at an all-time high since December.”
Then there’s what’s known as food fraud, which can mean adulterating food, or replacing it with an inferior product, or faking its origin. In Malaysia, some criminals are repackaging used cooking oil in tins or painted bottles to pass it off as palm oil, a staple that’s become more costly.
In India at least 500 people fell ill in April after consuming adulterated buckwheat flour.
Police say there’s a notable increase in the common practice of cutting spices such as turmeric and chili with cheaper—and often toxic—substances, including rice flour and aniline dyes.
Amarendra Panda, an assistant commissioner of police in Cuttack in the eastern Indian state of Odisha, says his officers have raided about 20 premises recently and confiscated what he calls “adulterated commodities” worth millions of rupees, or tens of thousands of dollars.
“Their motive was to earn huge profits by investing as little as possible,” he says.
U.S. lumber prices soared to an all-time high in May and are now more than double what they were a year ago. Copper is up 70% over the same period, having also hit a record last month. Global food prices increased for a 12th straight month in May to the highest in almost a decade.
“The value on the black market of commodities changes just like they do above board,” says Jim Yarbrough, who leads a team at the British Standards Institution that monitors supply chain risks, including terrorism. “That’s going to drive criminal activity just like all other forms of supply and demand.”
While soaring prices have provided an incentive for commodity-related crime, the pandemic has furnished fresh opportunities. Disruptions to supplies and reduced availability of some materials mean managers must at times resort to doing business with previously untested suppliers, says Kimberly Carey Coffin, global technical director at Lloyd’s Register, a quality assurance company.
Even seasoned buyers are in danger of being duped. Last summer, Swiss commodities trading firm Mercuria Energy Group Ltd. struck a deal to buy $36 million of copper from a Turkish supplier but got a load of painted paving stones instead.
Since the end of 2019, copper robberies in the northern Chilean province of Antofagasta have increased about 30%, according to Egidio Ojeda, an officer with Chile’s investigative police.
While some of that can be attributed to the remoteness of the mines and a surge in social unrest that preceded the pandemic, it also reflects a huge runup in the market price for the metal. “The operations are like a movie,” Ojeda says. “It’s a business that moves a lot of money, and even more now that prices have shot up.”
Thieves in trucks chase and try to intercept rail cars that depart from mines such as BHP Group’s Escondida or Zaldivar, which is operated by Antofagasta Plc, according to Ojeda. They pilfer one or two bundles of copper cathode sheets at a time, each valued at about 20 million Chilean pesos ($27,500).
In March police apprehended three people near train tracks. In their truck they found tools strong enough to cut through the metal straps that fasten the copper slabs.
Many business owners are beefing up their own security. Olusegun Olaniyi, a farmer in Osun state in southwestern Nigeria, is paying for guards to patrol his property to curb theft of cassava, corn, plantain, and other crops. The thieves come at night and in the afternoon when workers are on break, he says.
Akash Homes in Edmonton, Alberta, has endured repeated heists of lumber, with losses totaling C$100,000 ($82,915) since February, according to vice president Hersh Gupta. The company installed security cameras at its construction sites and joined forces with other builders on nearby lots to hire guards to patrol overnight and on weekends.
“It’s getting pretty crazy, to the point that thieves are starting to hot-wire zoom booms to load their own trucks,” he says, referring to a type of forklift.
The company now uses spray paint in a sky-blue shade that matches its corporate logo to tag its lumber with the letter “A” to help identify it if it’s stolen. But though some victims of lumber theft monitor online sales platforms such as Facebook Marketplace in search of stolen goods, markings are easily shaved off, making the wood unidentifiable.
Tackling food fraud, estimated to cost the food industry as much as $40 billion a year in lost sales, product recalls and legal bills, is even tougher. Because of complex supply chains, products change hands several times, often across borders, before they arrive on supermarket shelves.
Cases tagged as fraud, adulteration, or authenticity-based jumped 38% in the final quarter of 2020 from the same period in 2019, according to Food Forensics Ltd., a U.K. company that carries out testing and has a database mainly focusing on Europe.
“We are as busy as we have ever been, particularly with white flaky fish, tomatoes, rice, and other core commodities that are usually vulnerable to fraud,” says Rick Sanderson, business development director at Food Forensics.
The pandemic has complicated efforts to crack down on criminal activity. Police resources have been diverted, government or food safety inspectors can no longer visit factories in places like India, and sampling is difficult. At the same time, online marketplaces and delivery platforms are creating more opportunities for illegal goods to be sold, says Coffin at Lloyd’s Register.
“There is no likelihood my goods will get to their final destination, and when they do, there is high chance of pilfering of the goods during transit,” says Anugboba Ebhodaghe, whose food export company in Lagos, Nigeria, deals in everything from cashew nuts to cassava chips. “Everybody is like a hawk, looking for what to take at the slightest advantage.”
Metal Prices Fall As China Says It Will Release State Stockpiles In Effort To Control A Soaring Commodities Rally
Most metal prices in London and Shanghai fell early Wednesday before paring back losses as China ramped up its campaign to rein in commodity prices that have hit a 13-year highs.
China’s National Food And Strategic Reserves Administration said it will release state stockpiles of metals including copper, aluminum, and zinc, the agency said in a statement cited by Bloomberg. The country hasn’t released state reserves in years, and the move is expected to boost short-term supply and weigh on prices.
The stockpile release is the latest move out of Beijing to try and clamp down on soaring commodity prices, including a 67% increase in copper over the past year.
Last month, a government agency in China said the country will show “zero tolerance” for monopoly behavior and hoarding and will increase law enforcement inspections. The agency said “excessive speculation” had disrupted the production in commodities and contributed to price increases.
According to Bloomberg data, copper and zinc dipped in London after the Wednesday announcement from China. However, China’s buying power over metals doesn’t necessarily mean it will be able to tame global prices.
You’re Paying More for Food—and You Might Not Know It
Here are five ways that food makers, grocers and restaurants are making up for higher costs.
Eating is getting costlier for Americans as the food industry faces the steepest inflation in a decade. Big food makers and restaurant chains are raising prices, cutting their own costs and trying other strategies to offset higher expenses. Between shrinking grocery-store packages and fewer restaurant discounts, shoppers are paying more for their meals whether or not they notice it. Here’s How:
General Mills Inc., Campbell Soup Co. and J.M. Smucker Co. are just a few of the food makers raising wholesale prices, translating to higher supermarket price tags for Goldfish crackers, Folgers coffee and pet food over the summer and early fall, executives said. In restaurants, the Labor Department estimated prices increased 4.2% in June from a year earlier, with Chipotle Mexican Grill Inc., Denny’s Corp. and Shake Shack Inc. among the chains charging more this year.
Rising costs for ingredients, transport, labor and packaging are forcing companies’ hands, said General Mills Chief Executive Jeff Harmening. With consumers’ savings rates higher than ever and plentiful jobs, shoppers can bear it, he said: “No one wants to increase prices, but we’ve had to, and consumers understand.”
Grocery stores have also been amenable to food makers’ price increases. “We would expect to be able to pass those costs to customers,” Kroger Co. Chief Executive Rodney McMullen said. Worst case, he said, higher costs for major brand names will push shoppers toward Kroger’s lower-priced store brands, he said.
Conagra Brands Inc. Chief Executive Sean Connolly said the company recently raised prices on its Hunt’s canned tomatoes and Chef Boyardee products given high steel prices and other costs. “It’s still a really good value relative to other options,” like restaurants, he said.
Consumers may not notice, but some industry players are avoiding raising prices by instead cutting back on discounts. Cereal aisle giant General Mills is doing promotions, though with smaller discounts for each. Yogurt maker Danone SA is shifting discounts toward more expensive and profitable items. Other grocery makers are cutting back on extra displays in stores as a way to reduce promotional spending.
The promotions that kept diners coming to restaurants through the pandemic are shrinking, too. Olive Garden owner Darden Restaurants Inc. and Domino’s Pizza Inc. are among the chains no longer discounting as heavily. Carrols Restaurant Group Inc., the largest U.S. Burger King owner, expects its discounts to drop 3% this year as it offsets rising costs.
Some chains are promoting higher-priced items. McDonald’s Corp.’s recent Chicken McNuggets meal tied to Korean pop group BTS cost around $7 and up. Burger King’s new Ch’King sandwich averages between $3.99 and $4.99, compared with one-dollar cheeseburgers sold by the chain. “It is absolutely something that our system will be profitable with,” said Burger King Chief Marketing Officer Ellie Doty.
Oreo-maker Mondelez International Inc. and other food companies are turning to price-pack architecture—changing packaging and sizes while charging more per ounce. The snack giant pointed to its Oreo two-pack, a new, smaller size that costs less but carries a higher profit margin for the company.
Tillamook, a dairy co-operative in Oregon, shifted to 48-ounce ice cream containers from 56 ounces while keeping the price the same, in the face of higher costs.
More convenient packaging can also carry a higher price, like Kellogg Co. ’s new snack-packs of cereal. Food company executives said it helps to provide consumers something new and interesting to justify charging more.
Restaurants are similarly shrinking portion sizes, a tactic some owners prefer over raising prices, said Hudson Riehle, senior vice president of the National Restaurant Association’s Research and Knowledge Group. “The history is clear that consumers are sensitive to that,” Mr. Riehle said.
It can be a risky move if consumers catch on and feel jilted, said Andrew Pawling, chief operating officer of family-owned food maker FoodStory Brands. The company, which makes Fresh Cravings refrigerated salsas and hummus, is considering switching to packaging materials that use less plastic resin, which has increased dramatically in pricing this year. “We are looking for creative solutions to offset some of the pain,” Mr. Pawling said.
During the pandemic’s peak, U.S. food manufacturers cut the number of unique items they were selling by about 7% on average, according to NielsenIQ. Companies have said they aren’t bringing many of those back.
Simplifying restaurant menus has helped kitchens run more efficiently, saving money on employee training and reducing waste, restaurant operators said. Technomic Inc. estimated that sit-down restaurant menus listed one-fifth fewer items in the first quarter of 2021 than a year earlier. Restaurant executives expect some of those reductions to be permanent.
“It had gotten a little bit big and unwieldy for things that really don’t matter,” Denny’s CEO John Miller said about the chain’s menu.
In supermarkets, Mondelez saved money by eliminating 25% of its snacks, dropping less-popular package sizes and flavors. “This is a less-is-more” situation, said Mondelez’s North America president Glen Walter, making the company’s operations more efficient and allowing Mondelez to fill shelf space with higher-priced, higher-profit snacks.
Consumers aren’t the only ones paying for inflation. Food companies are also cutting costs through employee layoffs, reduced advertising, supplier shake-ups and increased automation. General Mills recently announced a reorganization involving corporate staffing reductions.
Big food manufacturers and restaurant chains also use forward-buying contracts and hedging tools to cut costs. PepsiCo Inc. said that has helped it cope with the inflation this year, though it still plans to raise prices after Labor Day.
“Our phone has been ringing off the hook,” said Buck Jordan, founder and CEO of Wavemaker Labs, a venture fund that helped back the “Flippy” burger-cooking robot used in some White Castle restaurants and other chains. “Every major fast-food chain is looking for solutions.”
Many restaurants built online ordering tools during the pandemic, which freed employees from taking orders. Chains like Applebee’s have equipped servers with digital tablets to speed up in-person order taking, while Yelp Inc. says demand is up for electronic kiosks that let diners check themselves in.
Lumber Prices Are Way Down—But Don’t Expect New Houses To Cost Less
Futures prices have dropped by about two-thirds since May, helping builders and do-it-yourselfers.
After rising to shockingly expensive levels this spring, lumber prices have fallen so far that they are starting to look cheap to some buyers.
Prices for two-by-fours surged in May to more than twice their previous record, set three years ago when there were about 15% fewer homes being built. But wood prices have since plunged back to levels resembling those before lockdowns cut supplies short and boosted demand.
July futures ended Wednesday at $521.40 per thousand board feet, down nearly 70% from the high of $1,711.20 hit in May, when wood-product supply lines were still being unknotted after the lockdown and before Americans began to shift spending from home improvement projects to vacations and dining out. More actively traded futures for September delivery settled at $612, which is $27 below the pre-pandemic high.
The decline is benefiting builders and do-it-yourselfers and helping to allay fears of runaway inflation hamstringing the economic recovery. Still, buyers of new homes shouldn’t expect discounts.
Home builders say they expect to collect higher profit margins rather than drop asking prices. That is typical following periods of rising commodities costs, when the broad economic growth that normally accompanies higher raw-materials prices enables companies to pass along more expenses.
An analyst recently asked KB Home Chief Executive Jeffrey Mezger on a conference call if the big home builder would share lumber savings with house hunters—lowering an average asking price that rose 13% to $409,800 during its fiscal second quarter ended May 31—or boost margins, which have climbed to their highest levels since 2006.
“It will depend on the competitive landscape in each city,” Mr. Mezger said. “But our hope and expectation is we’ll take it to margin.”
Rival Lennar Corp. said that it too expects higher margins during the current quarter on an average sales price of between $420,000 and $425,000, up from $414,000 in the fiscal quarter that ended on May 31 and from $367,700 a year earlier. The home builder is saving about $1,700 on its average-size house for every 10% that lumber prices decline, co-CEO Jon Jaffe told investors earlier this month.
It is a different story at Home Depot, which cooped-up Americans flocked to during the pandemic. The retailer has lowered its lumber prices in recent weeks. Eight-foot studs that were offered in Ohio stores for $7.48 on June 21 were priced at $6.25 on Wednesday. In Utah, pressure-treated two-by-four boards for outdoor use fell to $9.17 for an 8-foot length, down from $13.37 three weeks ago.
Retail prices remain high relative to historical levels, but the cuts show the decline in futures and mill prices is trickling down to shoppers.
Dealers, traders and price forecasters say sticker shock and the reopening economy have hurt retail lumber sales this summer. The bursts of demand from restaurants and bars building patios for outdoor seating are also in the rearview mirror. But the lower prices are beginning to beckon buyers, especially developers of big projects, like apartment buildings, which shelved construction plans when prices reached unprecedented levels.
“There were so many multifamily projects on the table that were ready to be built at $700 and got tabled,” said Matt Layman, a market analyst and consultant who publishes Layman’s Lumber Guide. “Now they’re back in budget.”
Home builders can pace construction in subdivisions with costs and the availability of materials in mind, but apartment developers don’t have that luxury. They order wood by the boxcar all at once.
The surge in prices pushed apartment lumber costs that might have been $3 million before the pandemic to $10 million, Mr. Layman said. That was a nonstarter for many multifamily developers, which have been slower to break ground than home builders.
Between their buying and vacation season winding down, Mr. Layman expects prices to get a lift in August. But then prices are likely to decline back to normal levels with the seasonal construction slowdown in autumn. “There’s not a reason in the world it can’t go back to $300,” he said.
Josh Goodman, vice president of purchasing at Melville, N.Y., supplier Sherwood Lumber Corp., said he told clients this spring to hold off buying wood if they could. Many didn’t. But those that waited have been barreling back into the market lately, particularly multifamily builders.
“There are people who have jobs on hold who are flipping the switch back on,” he said.
How Much More Will Your Oreos Cost? Companies Test Price Increases
A test will come later this year when buyers will have to choose whether or not to absorb additional increases.
American companies are starting to test the extent of their pricing power.
Faced with rising costs for materials, transportation and workers, companies are charging more for products from metal fasteners to Oreo cookies, helping fuel inflation like the U.S. hasn’t seen in more than a decade.
As customers accept the price hikes, some big companies said they expect to raise prices even more. Others are more cautious, unsure if U.S. consumers have the appetite to absorb additional increases.
What companies decide will go a long way to answering a question that has surged to the top of executives’ and economists’ agendas this year: Is the recent jump in inflation transitory, as the Federal Reserve predicts, or persistent, as some executives warn?
Fastenal Co. , a major distributor of industrial supplies such as nuts and bolts, and Conagra Brands Inc., a food conglomerate, illustrate the pricing dance playing out across the biggest U.S. firms. Both companies are passing along higher costs to customers. They have different views about what happens next.
Fastenal charged its customers enough extra in the first half of the year to offset its own higher product costs. But the company warns its ability to keep pace with costs could lag in coming months, in part because customer contracts put limits on price increases.
“In an environment where inflation continues to rise quarter after quarter after quarter, there are certain sticking points within our ability to push it through,” said Fastenal finance chief Holden Lewis. “Inflation in the marketplace can rise at a much more methodical and smooth pace than our ability to change prices can.”
Conagra, which makes Birds Eye frozen vegetables and Slim Jim meat snacks, among hundreds of other food products, couldn’t raise prices enough in the most recent quarter to make up for its own rising costs, including for cooking oils, packaging and transportation. It expects price increases and other measures to offset its costs later this year, and said it might need to raise prices further.
“We still think our products’ price points have room to move north based on the quality that we offer,” Chief Executive Sean Connolly told investors last week, noting that widespread increases across grocery aisles seem to leave consumers more willing to pay so far. “You don’t generally get a customer to accept inflation-justified pricing until they’re confident it’s not transitory inflation,” he said.
How hard companies continue to push to raise prices, and how well they succeed, is at the heart of the current concern about inflation. The more companies succeed, the more traction price inflation is likely to gain, keeping prices high and rising. If the price increases falter, inflation is likely to ease as labor and supply shortages diminish and the pandemic’s economic effects recede.
Of about a dozen large U.S. companies examined by The Wall Street Journal, most said they have succeeded in raising at least some prices but are unsure whether they can continue to do so. Several said they plan or hope to push additional price increases through.
“I don’t think anyone knows what the word transitory is really going to turn out to mean,” said Julien Mininberg, who heads consumer-products company Helen of Troy Ltd.
The maker of Pert shampoo and OXO potato peelers, Helen of Troy said it has raised prices selectively, including by introducing new products at higher price points. The company said it slowed price increases in its health and home division while working through some regulatory issues.
Before long, it plans to “go back to the customers and take those prices up,” Mr. Mininberg said in a July 8 conference call with investors.
Like many companies, Helen of Troy is combining price increases with other strategies to manage its own rising costs.
It has been building up inventory for the coming busy season ahead of recent cost increases in the market and using prenegotiated shipping rates that are below current prices, Mr. Mininberg said. The company expects to absorb $55 million to $60 million of inflation-related cost increases in the fiscal year ending in February.
European consumer-products giant Unilever PLC, which sells Dove soaps and Lipton tea, on Thursday said it would also raise prices beyond a 1.6% increase in the second quarter. Its shares fell on news that higher costs would likely eat into profits.
Most economists expect inflation to decline from its current 13-year high but are divided on when, or whether, it will fall enough to satisfy the Fed. The consumer-price index was up 5.4% in June from a year earlier.
The central bank’s preferred gauge, the price index of personal consumption expenditures, gained 3.9% in May from a year earlier. Fed officials in June projected this measure of inflation would ease to 3.4% by this year’s fourth quarter, and to 2.1% by the end of next year—near the Fed’s 2% target.
Economists surveyed this month by The Wall Street Journal also anticipate a decline from current levels but expect more inflation than the Fed. The median forecast anticipates 2.3% inflation by the fourth quarter of 2022, down from an annual rate of 3.7% in the fourth quarter of this year, also using the PCE index.
A University of Michigan survey conducted in late June through mid-July found that the median consumer expects prices to rise 4.8% over the next 12 months, a 12-year high.
All this points to the prospects of inflation running higher over the next year than it has for a long time.
In a poll of 606 U.S. businesses across industries, 33% said they are raising prices, while just 4% said they are cutting them, according to 451 Research, a unit of financial data firm S&P Global Market Intelligence. Retail and manufacturing businesses led the way, with 44% and 41%, respectively, increasing prices.
Chipotle Mexican Grill Inc. raised its menu prices by around 4% earlier this year, on top of increases the chain made on the price of delivered food last year. On Tuesday, the burrito chain said it hasn’t seen pushback from customers, and it believes it is proving its pricing power with diners.
“I actually see it as a long term strength of the company,” said CEO Brian Niccol. The company’s own freight and avocado costs are up.
Chipotle hasn’t yet decided whether to further lift prices. The company shifted to an average wage of $15 an hour last month, which it said hit second-quarter margins. More of those increased labor costs are expected to trickle into results during the current quarter.
Food companies are raising prices as commodity costs rise, and a number of them appear bullish on prospects for further increases.
Snack giant Mondelez International Inc. raised prices on Oreo cookies and other snacks this year, and told investors last month it is considering price increases for 2022 based on the commodity cost inflation it expects. That could mean smaller packages bearing the same price tag, or less discounting, both of which serve to raise the company’s average selling price.
Several brands said their planned price increases won’t be fully implemented in grocery stores until the second half of this year.
Price increases by Hormel Foods Corp. for products including its Jennie-O ground turkey and Skippy peanut butter so far haven’t covered the company’s higher costs for peanuts, oil and plastic containers, among other inputs, the Austin, Minn., company said. It expects more price increases later this year.
General Mills Inc. CEO Jeff Harmening, whose company makes Betty Crocker cake mixes and Cheerios cereal, said unusually high consumer savings might make Americans less sensitive to price increases than usual. Still, he added, they could cut back on food spending if companies raise prices too far. “The next few months will be especially critical,” Mr. Harmening said.
The company has said price increases and reduced discounting will be used to offset less than half its increased costs, with internal cuts and efficiencies making up most of the rest.
The company’s primary response to inflation is to become more efficient, General Mills spokeswoman Kelsey Roemhildt said.
But inflation is so high right now that productivity alone won’t solve it, she added. “Given the level of inflation that we forecast for the fiscal year, we will be using all tools in our pricing tool kit, including…list price increases where needed,” she said.
Some high-profile executives in the financial industry have cited a range of factors suggesting that higher inflation will persist—with caveats. Larry Fink, CEO of asset-management giant BlackRock Inc., has pointed to the shift in emphasis in Washington in recent years away from expanding global trade and toward creating domestic jobs, rebuilding U.S. manufacturing and various national-security issues.
Jamie Dimon, CEO of JPMorgan Chase & Co., also said higher inflation is possible as jobs proliferate and wages rise—but added that robust economic growth could more than offset the impact.
Mike Jackson, CEO of AutoNation Inc., the nation’s largest car dealership by sales, chalked up inflationary pressures in his industry largely to higher unemployment benefits related to the pandemic recovery, which helped push employee wages up, and a jump in used-vehicle values compared with a year ago when rental-car companies were liquidating their fleets.
“I very much agree with the view of the Federal Reserve, which is that you have some unique circumstances at the moment,” said Mr. Jackson, who has served on the board of the Federal Reserve Bank of Atlanta. “We have a transitory situation here, and things will look different by the end of the year.”
If companies really believed price increases will persist, they would start expanding operations, to reflect the expectation of continued higher prices, said Steven Blitz, chief U.S. economist of research company TS Lombard. He said he hasn’t seen it yet.
“They’re enjoying demand, they’re enjoying the high prices they’re getting, but I don’t see them leveraging their businesses to double production,” Mr. Blitz said. So far, he added, “they’re telling you they don’t trust what they see as permanent.”
Still, some executives do see longer-term price pressure, even beyond consumer sectors. Jeff Miller, chief executive of Halliburton Co. , the world’s second-largest oil-field service company, said during its second-quarter earnings call, that the company has been able to pass along to its oil-company customers its own increased costs for maintenance, parts and labor. He predicted a multiyear upturn in oil-patch activity, the first in seven years, and said equipment prices are already rising in North America.
Conagra, which has raised prices on its Armour Star canned meat line as protein and steel costs have risen, has watched as consumers accept higher prices across supermarket aisles. Grocery prices rose 0.8% in June from May, compared with the 0.4% month-to-month increase in the two prior periods, the Labor Department said.
“I think you call it strength in numbers,” Mr. Connolly, the CEO, said in response to an analyst question. He said he believes consumers are likely to be more accepting of higher prices due to their ubiquity throughout the supermarket, and that the relative affordability of groceries over restaurant food also helps.
Conagra executives said they expect inflationary cost pressures to be the worst in the company’s first quarter, ending this August, after which profit margins are expected to improve as price increases on its products take effect, along with productivity improvements and other cost savings, and the rate of inflation slows. As inflation persists, it becomes harder to manage, Conagra executives added.
Fastenal is leaning on price-management skills it honed in recent years managing cost increases sparked by tariffs. The company realized it needed to address price changes more tactfully, in part because customers were reluctant to swallow broad increases.
To help navigate pricing changes, Fastenal uses data to show how it sources specific products and why prices are changing, said Mr. Lewis, the CFO. The result: customers are more likely to accept targeted price increases.
Although Fastenal’s spending on metal, transportation and fuel has risen, its price increases have been smaller, because those inputs make up only part of its production expenses.
“Cost of goods has many, many components, not all of which are inflating,” Mr. Lewis said. Demand for the company’s products remains strong, and he doesn’t see signs of inflation abating right now, but he admits to having little visibility into the future.
Many of Fastenal’s customers are under contracts, some of which limit the company’s ability to raise prices, and it is difficult to constantly adjust prices to those customers that aren’t under contract. “If we raise prices on fasteners in June, it can be hard to come back in July,” he said.
“We think that we will be able to offset that [cost] inflation,” he said. “But the pace and timing of that depends very much on how the market continues to evolve around inflation and pricing and those sorts of things. It’s a pretty dynamic environment.”
Inflation Pushes Consumer-Goods Giant Unilever To Accelerate Price Increases
Warning from maker of Dove soap and Ben & Jerry’s ice cream follows similar moves by Procter & Gamble and General Mills.
The maker of Dove soap and Hellmann’s mayonnaise warned of accelerating price increases across a range of products, as it seeks to counter cost inflation across its business.
Unilever UL -5.43% PLC said Thursday that it was grappling with higher costs for ingredients, packaging and transportation, which would likely lower its full-year profitability—a warning that sent shares down 5% in early trading.
The London-listed consumer-goods giant said it would step up price increases across the world, having already raised prices 1.6% in the second quarter.
“We are going to have to take a little higher levels of price increase,” Chief Financial Officer Graeme Pitkethly told reporters.
Inflation has continued to pick up pace, rising at the fastest pace in 13 years in the U.S. last month as the recovery from the pandemic gained steam and consumer demand drove up prices of everything from autos to clothes and restaurant meals. Other packaged-food manufacturers, including Procter & Gamble Co. and General Mills Inc., have also warned of rising prices this year.
Mr. Pitkethly said Unilever’s large scale and strong inventories would help to mitigate the price rises but that several costs were out of the company’s control and rising more than expected. The price of ingredients such as palm oil, crude oil and soybean oil all rose sharply in the quarter.
Rising costs of commodities, increased marketing spend compared with last year and expenses linked to the Covid-19 pandemic have reduced Unilever’s profitability, with the company saying its underlying operating margin in the first six months of the year fell 1 percentage point to 18.8% from a year earlier. The company now expects a slightly lower profit margin for the year.
“We’re very focused on our pricing actions, which we think are landing well but inflation has been even higher than we anticipated,” Mr. Pitkethly said.
He added that the company had already been able to quickly increase prices in places such as Brazil and Argentina, but that doing so in Europe, for example, can take more time because the sales contracts it signs are often for longer periods.
The comments came as Unilever reported a 5.4% rise in first-half underlying sales growth to 25.8 billion euros, equivalent to $30.4 billion, boosted by strong sales of its food and refreshment products. It attributed 4% of that growth to higher sales volumes, with 1.3% coming from higher prices.
Net profit for the first six months of the year fell 5% to €3.12 billion because of a negative impact from currency fluctuations.
Asked by analysts about its ice cream brand Ben & Jerry’s decision to stop selling its products in Jewish settlements located in the Israeli-occupied West Bank and contested East Jerusalem, Unilever Chief Executive Alan Jope said the consumer-goods giant was committed to Israel and that the decision was taken by the brand’s independent board. Unilever bought Ben & Jerry’s in 2000 and pledged at the time to allow the brand’s directors to make decisions about its social mission.
James Edwardes Jones, an analyst at RBC Capital Markets, said the market was disappointed with Unilever lowering its margin guidance but that the company was also likely paying the price of being the first big European consumer goods firm to report.
“It’s a very tough environment,” Mr. Edwardes Jones said. “The reality is that inflation has been going up more or less in a straight line for the past six months and the company is reacting to that.”
Whirlpool Considering More Price Increases If Inflation Exceeds Forecasts
The appliance maker in the spring started raising prices by 5% to 12% to offset higher raw material prices.
Whirlpool Corp. , which manufactures washing machines, KitchenAid mixers and other home appliances, is considering additional price increases should inflation outpace its forecasts.
The Benton Harbor, Mich.-based company earlier this year raised sale prices for its products by 5% to 12%, depending on the market, to compensate for increased raw material costs, including for steel and plastics, and it could lift prices again if necessary, Chief Financial Officer Jim Peters said Wednesday.
Pricing is “one of the tools we haven’t hesitated to use in the past,” he said, adding that additional price increases could apply to certain categories, rather than the company’s entire product range. Whirlpool expects $1 billion in additional raw material costs this year.
At the moment, the price increases made earlier this year “will cover us,” Mr. Peters said, adding that could change depending on whether inflation goes up further or lasts longer than forecast. Whirlpool expects inflation will decline at the end of this year or early next year.
Some economists project heightened inflation will be transitory, but others forecast it will continue through 2023.
The price index for personal-consumption expenditures, the Federal Reserve’s preferred inflation gauge rose 3.9% in May from a year earlier, a larger gain than central bank officials had expected and higher than their target of 2% on average. Another inflation metric, the consumer-price index, increased 5.4% in June from a year earlier.
Whirlpool in recent years overhauled its processes and systems, which means raising prices across the portfolio doesn’t require as much labor as it did in 2011 and 2012, when the company faced similar levels of inflation, Mr. Peters said. Whirlpool raised prices by a high-single-digit percentage figure at the time, he said.
The company now uses Microsoft Corp. Excel spreadsheets and an enterprise software platform provided by SAP SE to calculate price increases, Mr. Peters said. “We are better at executing pricing,” he said. “We are also better at forecasting.”
Whirlpool is experiencing supply constraints for crucial components, such as microchips and plastics, which will extend into next year, Mr. Peters said, adding the company has adjusted production schedules in response.
Whirlpool, which sources materials from several thousand suppliers around the world, is looking to extend its contracts and find new suppliers, he said.
The CFO is keeping track of the different factors driving up costs and expects some of those expenses to ease once inflation and supply constraints normalize at the end of 2022 or in early 2023, he said.
Pricing actions tend to be relatively uniform across appliance manufacturers, according to David MacGregor, president and senior analyst at equity research firm Longbow Research LLC. “With steel, resins, components continuing to rise, additional pricing initiatives should not be ruled out,” Mr. MacGregor said.
Whirlpool, which reported a 31.7% increase in net sales to $5.32 billion for the second quarter from a year earlier, doesn’t expect higher sale prices to dent demand for its products, Mr. Peters said. “The only thing they are comparing is the competitive set,” he said, referring to consumers.
Inflation Stayed High (CPI 5.4%) In July Amid Supply Chain Problems
Consumer prices rose 5.4% from a year earlier, the same annual rate as in June, but the monthly pace slowed.
Inflation remained elevated in July as the economic recovery continued, but prices showed evidence of cooling amid pandemic-related supply problems and signs that the recent rise in coronavirus infections is starting to crimp some business activity.
Consumer prices rose 5.4% in July from a year earlier, the same pace as in June, the highest 12-month rate since 2008, the Labor Department reported Wednesday.
On a monthly basis, however, price pressures weakened. The department’s consumer-price index climbed a seasonally adjusted 0.5% in July from June, a significantly slower pace than its 0.9% increase in June from May, though well above the average 0.2% rate from 2000 to 2019.
The CPI measures what consumers pay for goods and services, including groceries, clothes, restaurant meals, recreation and vehicles.
The so-called core price index, which excludes the often volatile categories of food and energy, increased 4.3% from a year before, down from a 4.5% annual increase in June. Month to month, the core CPI rose 0.3%, also down sharply from the 0.8% average increase in the previous three months.
The weakening of price pressures in July from June isn’t necessarily a sign that the inflation fever of the past few months is breaking.
“It’s like the equivalent of going from a 104-degree to a 101-degree fever—it’s still elevated. It’s just not as hot as what we saw in the prior three months,” said Aneta Markowska, chief financial economist at Jefferies LLC. “There is still some pressure in the pipeline that should show up in the next few months.”
The latest inflation figures came amid growing concerns about the recent rise in Covid-19 infections, driven by the fast-spreading Delta variant, and reports that it has begun to dent economic activity. Southwest Airlines Co. said Wednesday it has seen a slowdown in bookings and a rise in trip cancellations this month and expects that to drag down third-quarter operating revenue. The carrier said that leisure passenger traffic and fares topped 2019 levels last month, before fears about rising infections took hold nationwide.
The Delta outbreak is also driving some consumers to curb restaurant visits and has prompted the return of mask mandates among certain retailers and municipalities. The weekly average of the number of seated diners tracked on restaurant-reservation platform OpenTable was down 8% from 2019 levels for the week ended Tuesday, a reversal since late June, when dining activity surpassed 2019 levels. Spending on air travel fell in late July, while that on fine dining has slipped, too, according to data from Earnest Research, which tracks trends in credit-card and debit-card purchases.
Airfares dropped slightly in July, reversing a sharp rise in recent months, and they remain below pre-pandemic levels, the Labor Department said.
Prices for hotels and motels rose again in July, having surpassed 2019 levels in June. Prices for eating out shot up 0.8% in July from June, the biggest monthly increase since February 1981, driven by a rapid rise in fast-food prices.
The Delta variant’s impact could exacerbate the slowdown in economic growth under way, though it is hard to tell how much, said Joel Naroff, chief economist at Naroff Economics LLC.
“We could have countervailing forces—Delta, bankruptcies, and some government programs ending versus new government stimulus,” he said, referring to Biden administration budget proposals. “That seems to argue for a steady moderation in growth, not a rapid deceleration.”
Inflation has heated up this year as booming demand outpaced the ability of businesses to keep up. U.S. gross domestic product rose at a rapid 6.5% seasonally adjusted annual rate in the second quarter, powered by consumer spending that climbed at an 11.8% pace as more people got vaccinations, businesses reopened and trillions of dollars in federal aid flowed through the economy.
Gasoline prices picked up 2.4% in July from June, while grocery prices climbed 0.7%, both categories rising at a slightly slower monthly pace than in June. Among the supermarket items that jumped the most were pork roasts and ribs, which climbed 4.4%, and prepared salads, up 4.1%.
However, prices for coffee fell in July, after rising in June, as did those for fruits and vegetables, with orange prices declining 6.8% from June.
A semiconductors shortage has crimped auto production, causing prices to soar this year for new and used vehicles, as well as rentals. But used-car price growth slowed sharply in July, as prices rose 0.2% from June, after jumping at least 7.3% in each of the previous three months. New-vehicle prices picked up 1.7%, a slightly slower pace from June. Both are up markedly from pre-pandemic levels.
Many economists expect higher inflation to persist for a while, though declining gradually. Those surveyed by The Wall Street Journal in July estimated on average that annual inflation, measured by the CPI, would slow to 4.1% in December. The rate averaged 1.8% in 2019, before the pandemic hit the U.S. economy in March 2020.
Economists are forecasting growth to slow in the second half of the year, after a burst of growth fueled in the spring by widespread business reopenings, rising vaccination rates and a big infusion of government pandemic aid. As those effects fade, consumer spending gains should slow, and that should help tamp down price pressures, economists say.
Inflation is eating into household spending power despite wage increases in some industries. Average hourly earnings of private-sector workers, adjusted for inflation, fell 0.1% in July from June on a seasonally adjusted basis, the Labor Department said. Wages in the leisure and hospitality industry, where labor shortages are unusually acute, rose 0.4% from June, adjusting for inflation.
Rent is one category that many economists are monitoring as they seek to gauge inflation’s future path. The Labor Department collects data on new and existing leases to measure both rent on a primary residence and so-called owners’ equivalent rent, which estimates what homeowners would have to pay each month to rent their own home. Combined, these rent measures make up about one-third of the CPI prices for a hypothetical basket of goods and services, which means a pickup could buoy the overall inflation reading.
Both measures climbed in July at the same pace as in June, with rent up 0.2% from the prior month, while owners’ equivalent rent rose 0.3%. Rent has risen steadily since late last year, when it was suppressed by a combination of pandemic-related forces, including an exodus from higher-rent big cities.
“The economy is reopening, so young adults that had moved in with their parents are moving back out and returning to cities,” said Ms. Markowska. “What’s also happening, though, is that people just have more money than they’ve had in a long time.”
Adam Tannenbaum, whose company owns workforce-housing units in central Pennsylvania, was surprised when tenants proved willing to accept recent rent increases on the order of 10% or more a year.
He said he was stunned when a bidding war broke out over a Columbia County, Pa., unit in May. “We advertised it at $725 thinking the economy’s not that strong out here. Well, it got up to $950—that’s when I stopped it,” said Mr. Tannenbaum, a managing principal at The Denali Companies, a workforce-housing investment firm. On top of that, the winner was also willing to pay six months up front plus a security deposit before moving in, he said.
“I don’t know where these people are getting their money from, but there’s a lot of money out there and there’s definitely a shortage of these very standardized workforce units,” he said. This, he added is in “places where employment drivers are usually a university or an Amazon warehouse.”
US July Consumer Price Index Rose Slightly Faster Than Expected
A year-over-year gain of 5.4% may reflect an economy that’s still suffering from supply shortages while keeping up with increasing demand.
The U.S. Consumer Price Index jumped by 5.4% in the 12 months through July, the same pace as June but slightly exceeding the 5.3% increase expected by economists, the Labor Department reported Wednesday.
Core CPI, which excludes food and energy prices, rose 4.3% year-over-year, lower than economists’ expectation of 4.4%.
Prices rising while interest rates remain low could lead more investors to pour into bitcoin (BTC, -1.91%) over bonds as a reward for paying those higher prices. Bitcoin traders closely track headline inflation numbers in the event that the premiere digital asset becomes a hedge against inflation because of its limited supply cap.
The Labor Department’s Bureau of Labor Statistics reported the increase, which compares July 2021 prices to those from July 2020 and shows an economy that’s working through supply constraints while trying to meet increasing demand. On a month-to-month basis, which takes out how much prices dipped in 2020, consumer prices rose 0.5%
The July CPI report may not influence tapering discussions at the Federal Reserve. In last month’s Federal Market Open Committee (FOMC) press conference, Fed Chair Jerome Powell noted that the central bank is aiming to make gains in its goal to reach maximum employment before tapering. (The Fed’s quantitative easing program brings more liquidity to the markets through quantitative easing that gives investors the liquidity to invest more in riskier assets like bitcoin.)
The Rest Of The Report Was Illustrative Of Easing Bottlenecks In The Global Supply Chain. On A Month-Over-Month Basis:
* Used vehicle prices rose by 0.2%, slowing June’s trend of high demand for used automobiles in lieu of new ones, when prices for used autos increased by 10.5%.
* Airline fares fell slightly by 0.1%, compared to June’s 2.7%.
* The food index increased by 0.7%, compared to June’s 0.8%.
* The energy index increased by 1.6% with the gasoline index rising by 2.4%.
What Another $3.5 Trillion Could Do To Inflation
The Democrats’ outsized budget proposal has the potential to overheat a U.S. economy that is already struggling to keep up with record demand.
With inflation at its highest level in several decades, centrist Democrats are beginning to echo Republican concerns that the Democrats’ $3.5 trillion spending package will further overheat a U.S. economy already struggling to keep up with demand. Those worries are justified — but critics shouldn’t get ahead of themselves.
Inflation will almost certainly drift downward in the near term even if the full package is passed into law, which is unlikely. The real concern is that the package would exacerbate more fundamental supply constraints in the economy, driving up inflation over the longer term.
To see clearly what’s going on, it’s necessary to separate the inflationary pressures into three parts: increases in overall spending in both the public and private sectors; supply-chain disruptions directly related to Covid; and a puzzling weakness in the the job market.
The best way to view the first is to look at nominal GDP, a measure of total spending in the economy without correcting for price changes. Slowdowns in NGDP growth are a hallmark of demand-driven recessions, and recoveries from those recessions tend to be weak until NGDP returns to its pre-recession path.
The collapse of NGDP in the spring and summer of 2020 was historic, dwarfing what was seen after during the Great Recession. Yet, because of the enormous relief packages passed by Congress and the unconventional interventions of the Federal Reserve, the rebound in NGDP has been equally unprecedented.
Increases in public and private spending over the last year have been just enough to get the economy back on track without generating excess inflation. Under normal circumstances, this would be a Goldilocks economy: not too cold, not too hot.
Circumstances, however, are far from normal. The pandemic has generated supply-chain disruptions — particularly in the auto industry, construction materials, food and energy — that are driving prices higher and sapping spending power from the rest of the economy. Used-car prices rose a staggering 41.7% over the last 12 months, almost exactly matching the 41.8% increase in the cost of gasoline.
Instead of a Goldilocks economy, the U.S. is risking stagflation: rising prices combined with sluggish job growth. It’s understandable, then, that both Republicans and centrist Democrats are wary of even more spending.
They can take some solace in the likelihood that these extreme price increases are likely not only to slow but also to reverse themselves in the coming months. Lumber costs for construction companies soared 125% between April 2020 and July 2021. But they were already falling in June, the last month for which data is available, and will inevitably fall further given the sharp decline in futures prices since May.
The less comforting facts come from the service sectors and housing. Restaurants, hotels and other recreation services are seeing high prices despite the fact that demand for those services is still muted because of Covid.
Wages are rising in those industries as well. It’s tempting to say these increases are also a transitory effect of the pandemic. Fear of Covid, lack of child care and the lingering effects of unemployment insurance bonuses are undoubtedly making it harder for employers to fill positons.
Wage increases, however, are extremely difficult to roll back — and so employers tend to be reluctant to offer them in response to a temporary shortage. So rising wages is an indication that few businesses are expecting a surge in job applicants once schools reopen and unemployment bonuses run out.
As for housing, existing home prices are rising at a record pace. Perhaps that’s simply due to newly remote workers trading in their cramped city apartments for more space in the suburbs or beyond. Even if so, such increases would typically lead to a boom in new-home construction that would provide jobs and increase the housing stock.
Yet after a sharp jump in June, new home sales have steadily fallen. That suggests a more profound mismatch between supply and demand that can’t be explained by lumber prices alone. If the imbalance persists, it could lead to steadily rising values of “owner’s equivalent rent,” a key component of inflation.
Put all this data together, and it’s plausible that the failure of the job market to recover — there are still about 7 million fewer jobs than there were before Covid — isn’t due to a lack of overall spending. It’s due to supply constraints; the spending is leading to higher prices instead of more jobs.
Some of the more extreme constraints will ease on their own, bringing down the overall rate of inflation. But more fundamental constraints seem likely to persist. It’s these constraints that President Joe Biden and Democrats should be worried about as they continue their efforts to add even more spending to the economy.
Inflation Isn’t Going Away Just Yet, Producer Price Index Shows
Wednesday’s consumer-price index provided evidence that inflation may be transitory. Thursday’s producer-price index showed that it may be sticky after all.
Producer prices rose 7.8% in July year over year, above the consensus forecasts for 7.3%, while increasing 1% month over month, above expectations for 0.6%. Instead of colling off, inflation for producers remains hot, hot, hot.
That’s in sharp contrast to Wednesday’s CPI report, which showed prices rising at a slower pace and bolstering the Fed’s argument that price increases were transitory. Now, the market will have to contend with another month of arguments about whether inflation is here to stay or not.
The initial reaction, however, has been tepid, at least from stocks. The Dow Jones Industrial Average is up 019 points, or 0.1%, while the S&P 500 and the Nasdaq Composite are little changed. The 10-year Treasury yield, however, has jumped to 1.3682, up 0.0293 percentage point.
Prices Paid To Producers In U.S. Increase More Than Forecast
Prices paid to U.S. producers rose in July by more than expected, suggesting that higher commodity costs and supply bottlenecks are still adding to inflationary pressures for companies.
The producer price index for final demand increased 1% from the prior month and 7.8% from a year earlier, Labor Department data showed Thursday. Excluding volatile food and energy components, the so-called core PPI also rose 1%, a second-month of record gains.
Compared with July 2020, the core index was up 6.2%. The advances in the overall PPI and core measure from a year ago were the largest in annual data back to 2010.
The median forecasts in a Bloomberg survey of economists called for a 0.6% month-over-month advance in the overall PPI and a 0.5% increase in the core figure. The PPI has exceeded estimates for five months.
Producer prices have been accelerating for much of this year against a backdrop of robust demand, supply chain constraints and shortages of materials. The increases in input costs, combined with recent upward pressure on wages, help explain higher consumer inflation.
A report Wednesday showed the consumer price index climbed in July at a more moderate pace, though not enough to provide major relief from the cost increases weighing on sentiment and driving policy debate.
Federal Reserve officials, including Chair Jerome Powell, say recent price increases represent temporary shocks that are associated with the reopening of the economy. Some policy makers and investors, however, worry that cost pressures will lead to more persistent inflation.
As with the CPI data, the producer price report showed a shift in inflationary pressures from goods to services.
Almost three-fourths of the jump in the July PPI reflected a record 1.1% pickup in services. The advance in final demand services was broad and included strength in margins at wholesalers and retailers.
Indexes tracking margins for airline passenger services, hospital care and accommodation also increased during the month.
The PPI report showed prices for goods increased 0.6% after a 1.2% advance in the prior month.
Prices of energy climbed by the most in four months, while food costs fell for the first time this year.
Producer prices excluding food, energy, and trade services — a measure often preferred by economists because it strips out the most volatile components — jumped 0.9% from the prior month, the most since January. Those costs were up 6.1% from July 2020.
Costs are advancing at a robust clip earlier in the production pipeline as well. Processed goods for intermediate demand rose 1.7% in July and were up 22.9% from a year earlier. The annual increase was the largest advance since 1975.
Nearly one-fifth of the monthly gain was attributed to a surge in prices of cold-rolled steel sheet and strip.
Inflation Is Here. The Big Debate Is, Will It Stay?
The U.S. Federal Reserve and investors in the bond market have traditionally been seen as hard-eyed cops on the inflation beat, ready to spring into action when prices rise. But this year, as inflation surged to a level not seen in more than a decade, both have remained surprisingly serene. Plenty of other people, however, are worried.
1. How Did Inflation Get Going?
In March 2020, the lockdowns in response to the coronavirus pandemic triggered the steepest U.S. economic downturn on record. Then in early 2021, mass vaccinations and trillions of dollars in stimulus from the federal government led to a pickup in consumer spending. Supply chains, on the other hand, took longer to rev up. Semiconductor production, for example, slumped during the 2020 lockdowns, and then couldn’t be ramped up fast enough when demand for cars and electronics returned, leading the prices of new and used autos to rise at a record pace. Prices for airfares and hotel stays also jumped. Companies found themselves short of workers as they reopened, leading some to offer bonuses or boost wages and subsequently raise prices for consumers.
2. Where’s The Disagreement?
The question is whether the inflation seen so far in 2021 is transitory. That is, whether those factors pushing prices up persist or prove temporary as supply chain constraints are resolved, more Americans return to the workforce and demand for travel normalizes. There’s not a clear answer from the data so far: While prices in some categories — like used cars — have started to come off the boil, those in other categories have begun picking up in recent months. The concern among those who think inflation pressures are more than a blip is that they persist long enough to become self-perpetuating, as happened in the U.S. and elsewhere in the 1970s, when expectations of inflation fed what was known as a wage-price spiral.
3. What Does The Fed Think?
The Fed is firmly in the transitory camp. In July, Fed Chair Jerome Powell said that current price pressures represent temporary shocks associated with the reopening of the economy. Lumber prices, for example, spiked when demand for new homes returned and have since normalized. “Our expectation is that these high inflation readings that we’re seeing now will start to abate,” Powell said in June. “And it’ll be like the lumber experience, and like we expect the used-car experience to be.” He has acknowledged that annual inflation figures running above the bank’s 2% target bring heightened uncertainty. “We don’t know when they’ll go away,” he said of recent price hikes. “We also don’t know whether there are other things that will come forward and take their place.” But he added that what the Fed isn’t seeing is “broad inflation pressures showing up in a lot of categories.” Powell and other Fed officials are also seeking to avoid repeating past mistakes.
4. What Mistakes?
Choking off an economic recovery through misplaced inflation fears. Before the pandemic, the Fed spent a decade trying to pull inflation up to 2% after it fell steeply as a result of the 2008 financial crisis. It began raising interest rates as the economy began to grow even though inflation remained tame, but had to reverse course in 2019. The Fed has a dual mandate of achieving both price stability and maximum employment, and Powell has repeatedly noted that nearly 6 million Americans remain out of work compared with pre-pandemic levels. The Fed’s official position is that it won’t begin winding down the stimulus it’s giving the economy through massive purchases of bonds until it sees “substantial further progress” in the labor market.
5. What Are Investors Thinking About Inflation?
Judging by what they’re willing to pay in the U.S. Treasury market, they’re not worried. So-called breakeven rates — the amount of extra yield investors demand to offset expected inflation — surged briefly in May but moderated to levels consistent with inflation matching the Fed’s 2% target. The “five-year five-year forward” breakeven rate, which measures expectations for the compensation needed to offset inflation for the period between five and 10 years ahead, is below the five-year rate, which suggests investors see inflation moderating over time. And models maintained by Fed economists that attempt to extract investor expectations for inflation from breakeven rates also indicate a decline over the last few months.
6. Who Is Worried About Inflation?
Most Wall Street economists, as well as those in the White House, are on Powell’s side. But some big names aren’t — especially those who experienced the rapid inflation of the 1970s. Former Treasury Secretary Larry Summers, who served in the last two Democratic administrations, has repeatedly predicted that the current combination of monetary and fiscal stimulus, coming on top of the reopening of the economy, will spark considerable pressure for price increases.
7. Who Else?
Republicans in Congress, meanwhile, have seized on the inflation surge to rally support ahead of the 2022 midterm elections and portray the administration’s plans for trillions of dollars more in spending as “reckless.” President Joe Biden’s administration hopes to pass a $3.5 trillion package of social spending and tax increases on the heels of the $550 billion infrastructure plan passed by the Senate on Aug. 10.
8. What Has This Meant For Workers And Consumers?
Thus far, consumers are paying up, as companies that are having to pay more for their inputs have largely been able to pass those costs on to their customers. Many people added to their savings during the pandemic — and were highly motivated spenders after being cut off from many pleasures. But the longer-term outlook for spending may depend on whether inflation-adjusted wages increase as much as prices. A recent study by the Peterson Institute for International Economics found that compared with December 2019, workers in most U.S. industries are seeing any wage increases being more than offset by inflation.
9. What’s At Stake?
If inflation proves persistent — meaning outsize price increases continue into next year and beyond — Fed officials will have to reevaluate their assessment of how soon to raise interest rates and pull back monthly bond buying. But at the same time, the Fed has to keep risks to its outlook in mind. The spreading delta variant has jolted investors who worry it could threaten the economic recovery. “As long as Covid is running loose out there, as long as there is time and space for the development of new strains, no one is finally safe,” Powell said following the July Federal Open Market Committee meeting.
Coffee Jolt Gets Pricier As Costs Of Beans, Labor, Transport Rise
In addition to coffee, Americans are paying more for many things—including hotel stays, other groceries and gasoline—as the economy rebounds from Covid-19’s impact over the past year. Companies are facing higher costs for labor, commodities and shipping, and they are passing them on to consumers in many cases. Consumer prices rose 5.4% in July from a year earlier, the same pace as in June, the highest 12-month rate since 2008, the Labor Department reported Wednesday.
Cafes and retailers lift prices, while others try to hold the line; ’Consumers will be looking for more affordable options’.
Many coffee drinkers can expect to pay more for their cup of joe at supermarkets and cafe registers, as producers grapple with higher coffee bean prices, constrained supplies and other costs.
Retail brands like Folgers, as well as independent coffee chains, are raising prices or plan to soon, executives said. Starbucks Corp. and Nestlé SA have said they could increase prices, while other coffee sellers try to hold prices steady, aiming to capture more business.
Coffee roasters and cafe operators are responding to poor harvests in major coffee-growing regions and logistics snarls that executives said have constrained bean supplies, delayed shipments and boosted costs. Companies are also raising wages to recruit and retain workers.
The supply chain issues are likely to worsen as a cold snap in Brazil, the world’s biggest coffee producer, is expected to reduce next year’s crop. The price of coffee futures traded on Intercontinental Exchange Inc. markets this year has averaged about $1.43 per pound, the highest it has been since 2014, according to Macrotrends LLC.
FairWave Holdings LLC, a Kansas City company that operates 20 cafes and sells packaged coffee, has raised menu prices and slowed hiring in response to escalating costs, executives said.
“In my 35-plus years of experience, this is one of the most rapidly rising cost environments that I’ve seen,” Dan Trott, the company’s chief executive said.
Nestlé, which produces Nescafé instant coffee as well as Starbucks-branded packaged coffee, said that while it has hedged coffee costs, it may raise prices as supply-chain costs are set to have a bigger impact in the second half of the year. NuZee Inc., a specialty coffee company that focuses on co-packing single-serve coffee, said it has enough coffee to last until the next quarter, but expects to pay higher prices once that inventory runs out.
J.M. Smucker Co. , which owns Folgers and produces Dunkin’ ground coffee, said it is trying to trim costs in its supply chain and has raised prices too. “We are seeing inflationary costs impacting the entire fiscal year,” said Tucker Marshall, the company’s chief financial officer, on a June conference call.
Supermarket sales of coffee have stayed high even as consumers go out more. Retail sales of coffee jumped from roughly $10 billion in 2019 to around $11 billion in 2020, according to market research firm IRI, and totaled almost $11 billion for the 52-week period ended July 11, the firm estimated. After major coffee chains’ sales dropped to about $30 billion in 2020 from around $34 billion in 2019, sales this year are on pace to approach 2019 levels, according to data from food-service consulting firm Technomic Inc.
Some coffee companies hope to take advantage of inflation to attract new customers. David Kovalevski, chief executive of instant coffee company Waka Coffee, said the coffee beans he buys from India and Colombia have gone up in price. Waka is trying to purchase coffee and other raw materials in bulk to negotiate lower prices and minimize freight costs, Mr. Kovalevski said.
Despite inflationary pressures, Waka hasn’t increased prices. Instead, Mr. Kovalevski said he hopes to lower prices and offer a cheaper alternative to other companies’ brews. “Consumers will be looking for more affordable options,” he said.
Defensive strategies have helped insulate some major buyers from rising coffee costs. Executives of Starbucks said last month that the company has more than one year’s worth of coffee on hand, with favorable prices locked in. JDE Peet’s NV, an Amsterdam-based coffee supplier, has hedged its own supplies this year, CEO Fabien Simon said last week.
Starbucks executives said the Seattle-based chain plans to promote premium beverages such as cold coffee to help compensate, and could lift prices in some areas, as the company faces higher labor and supply costs.
In Flushing, Mich., coffee shop chain Coffee Beanery has shielded itself from rising coffee prices by purchasing its supplies in advance, said Laurie Shaw, the company’s chief operating officer. But rising shipping and labor costs led the company to increase prices by an average of around 7%. As coffee costs have risen further, the company is considering another 10% increase, Ms. Shaw said.
Coffee companies say customers have been understanding of price increases because they are seeing higher costs everywhere.
Lisa Bee, chief executive of cafe chain Sweetwaters Coffee & Tea, said that because buying a cup of coffee tends to be a minor expense, her customers haven’t minded the price hike. Sweetwaters sells specialty coffee and recently increased its prices by around 5% to 10%.
“Even if there is a 10%, 15%, even 20% increase, you’re not talking about a lot,” she said.
The Price of Your Morning Cup of Coffee Keeps On Rising
The price of a cup of coffee keeps rising — and nobody seems to care.
Prices for arabica beans are up 50% in the past 12 months, hitting seven-year highs in July after drought and frost damaged crops in top producer Brazil and signaled tight world supplies for at least two years. The rally comes as high freight costs and shipping container shortages continue to rattle global supply chains, squeezing margins and heightening inflation fears.
Many consumer-facing businesses face a stark choice: raise prices or switch to cheaper beans.
The good news? Coffee drinkers are so addicted that consumption is unlikely to be hurt much, especially with demand still recovering from the pandemic.
The drink is “such a key part of [consumers’] daily routines, it would take a lot to change their coffee habits,” said Darren Seifer, food and beverage industry analyst at research firm NPD Group. Customers are “accustomed” to volatile prices, he added.
This year, global coffee consumption is expected to rise to 168.8 million 60-kilogram bags, according to Rabobank International, up from 164.8 million bags in the previous period.
The world market is expected to expand at a compound annual rate of 9% over the next three years to “well over $400 billion,” Starbucks Corp says. In Asia — the fastest-growing coffee market — consumption will rise thanks to bigger incomes and a burgeoning cafe culture in China, India and Indonesia, according to Fitch Solutions.
Demand for coffee is not completely unshakable: The pandemic brought the first dip since 2011.
But while higher prices this year may curb the post-pandemic rebound, consumption won’t decrease, Rabobank analyst Guilherme Morya said.
Prices would have to climb above $4 a pound to start making a dent in consumption, according to Sterling Smith, director of agricultural research at AgriSompo North America. Until then, price-sensitive consumers may seek out cheaper cafes or make more coffee at home, he said.
The impact will differ according to region, said Vanusia Nogueira, director of the Brazilian Specialty Coffee Association. Consumers in producing nations like hers tend to be more price-sensitive, she said, while coffee drinkers in wealthier places like Europe and the U.S. are less affected. There’s already a switch toward cheaper robusta beans in Brazil, according to Rabobank.
For companies like Starbucks, coffee beans represent a small part of overall costs compared with labor and rent. Still, the world’s largest cafe chain says it is feeling inflationary pressures.
“Pricing will be one of many levers that we use to offset these headwinds,” the company said, as well as encouraging consumers to buy more expensive items like food and cold drinks.
Nestle SA Chief Executive Officer Mark Schneider said “premiumization and the higher price point” give the maker of Nespresso and Nescafe options. “Where appropriate, we’ll raise prices,” he said.
Some businesses may try tactics such as fewer free refills or reducing the weight of packages without changing prices, said Judy Ganes, president of J. Ganes Consulting.
For smaller coffee shops, charging more may be easier than altering the taste of loyal visitors’ daily cup.
“Some of our customers have been drinking [our blends] for many, many years. If we change them, they’ll notice it,” said Marissa Crocetta, manager at London’s Algerian Coffee Stores, which has been selling coffee since 1887.
“If [raw coffee prices] go up dramatically with all the other costs then we’ll have to increase our prices.”
The Gold Standard – 50 Years Later
Yesterday was the 50th anniversary of President Nixon taking the US dollar off the gold standard. While you may be familiar with the basics, there is quite a bit to unpack from that historic moment.
First, let’s take a look at what Nixon’s exact comments were when he decided to execute this idea.
You Can Read More Of The Speech Here:
The language used here was important. There was reference to the American economy being the strongest in the world, the importance of defending the US dollar against speculators, the promise of temporary action, and of course – the confirmation that the US dollar would be stable and immune from being devalued.
Cute idea, but historically this has been proven to be one of the worst policy decisions in history. Don’t believe me? Our friends over at River have collected a few charts to highlight the impact:
Just incredible to see the impact of the United States going off the gold standard. Remember, President Nixon said that “inflation robs every American, every one of you.” That is correct. But while he was referring to pre-1971 conditions, he should have foreseen how destructive his decision would be.
It is interesting to look back on the 50 year anniversary and realize that we currently are experiencing 5.4% CPI and 4.3% core inflation numbers. These are basically the highest they have been in decades.
There are currently 78% of Americans who live paycheck-to-paycheck and 45% of Americans who hold no investable assets. These are the people who have suffered at the hands of poor policy decisions. While disheartening, the free market appears to have created a brand new global competitor — bitcoin.
There is no need to replace the US dollar in the short term, so bitcoin is likely to serve as the global store of value for decades to come. The transparent, programmatic monetary policy of a digital currency that has decentralized infrastructure is too powerful an idea, especially when compared to the backdrop of continued insane monetary and fiscal policy decisions. The legacy organizations are doing just as much to market an alternative store of value as any bitcoiner could dream of.
As Niall Ferguson wrote in a Bloomberg Opinion piece this morning, “If we have learned nothing else from the past half-century, it is surely that the best way to win a race with totalitarian rivals is not to copy them, but to out-innovate them. Make the wrong decision at this historic turning point, and we shall be interrupting a much bigger bonanza than Nixon did.”
If you have any material amount of wealth, you are not able to preserve it by holding US dollars, bonds, or gold. All are producing negative real rates of return. You essentially are left with bitcoin or equities, which leads you to consider an allocation to bitcoin given the high degree of volatility that will likely serve to outperform equities over a long enough time period.
We are living in weird, weird times. President Nixon kicked off the fiat experiment in 1971 and 50 years later, we are watching the global adoption of a potential solution to that problem. There is still a lot of work to do. Plenty more people to educate around the structural disadvantage they have as they pursue financial security in the legacy system. But….slowly we continue to head in the right direction.
Stay alert out there. Make sure you are educating yourself as best you can. The uncertainty and chaos of markets can be calmed by further understanding of history.
Inflation Is Rearing It’s Head In Latin America As Well
The U.S. Federal Reserve, like many other central banks, sees inflation from the reopening of economies disrupted by the pandemic to be “transitory,” and it’s not expected to raise interest rates until at least next year. Latin America’s policy makers, by contrast, are rushing to reverse ultra-low borrowing costs. In the last five weeks, central banks in Brazil, Mexico, Peru, Chile and even Uruguay have increased rates, while many expect Colombia to follow soon. Latin America was perhaps hit harder than any other region by Covid-19 and is experiencing a quick economic rebound that puts pressure on prices. Other reasons for the difference, though, may have to do with the continent’s high levels of inequality, informality and political instability — together with a history of inflationary bouts deeply etched into the collective economic memory.
1. What’s Been Driving Inflation?
Around the world, prices have been rising faster than usual as the end of many pandemic-related restrictions released pent-up consumer demand that disrupted supply chains have struggled to meet. Some factors have affected Latin America in particular. For instance, the global rally of food and energy prices has had a disproportionately large impact on the world’s most unequal region: food prices make up a greater share of inflation indexes in Latin America than in advanced economies like the U.S. That means that soaring food prices — beef is up 43% in Brazil — have played a larger role in overall inflation.
2. Are There Other Factors Specific To Latin America?
Yes. Many countries in the region are also net energy importers, and have seen surging gas prices as rising demand has led to tighter global oil markets. Recent social unrest has triggered volatility in some currencies too. There’s a strong tie between prices and currencies in Latin America, and devaluations almost immediately show up in inflation. Meanwhile, governments face continued pressure to sustain increased social spending adopted to combat the jump in poverty caused by the pandemic. The prospect of larger deficits has both soured investors on the currency outlook and increased their inflation expectations, which often causes local businesses to raise prices more and workers to demand higher pay increases in the near-term to hedge against future inflation. All this comes on top of being a region with a history of high inflation: It averaged over 100% annually in the late 1980s and early ‘90s, according to the International Monetary Fund.
3. How Bad Is Inflation And What Have Central Banks Done?
Here’s How Inflation Is Currently Affecting Monetary Policy In Latin America
July Consumer Prices In:
* Brazil: 9% Y/Y (Highest Since 2016)
Central Bank: Four Rate Hikes Since March Totaling 325 Basis Points To 5.25%
* Mexico: 5.8% (Near Highest Since 2017)
Central Bank: Two Quarter-Point Hikes To 4.5%
* Peru: 3.8% (Highest Since 2017)
Central Bank: First Hike In Five Years To 0.5%
* Chile: 4.5% (Highest Since 2016)
Central Bank: 25 Basis Point Hike To 0.75%
* Uruguay: 7.3% (From 10% A Year Ago)
Central Bank: 50 Basis Point Hike To 5%
* Colombia: 4% (Highest Since Late 2017)
Central Bank Signaled It May Soon Raise Rates
4. Why Are The Region’s Central Banks Acting Now?
They’re trying to head off the kind of deterioration in exchange rates that commonly occur in emerging economies when inflation expectations rise. Latin America is already home to four of the six worst performing currencies in emerging markets this year. They’re also reacting to a stronger-than-expected economic recovery — the region is set to grow this year at the fastest pace since 2009. Then there’s an unsettled political backdrop, with violent protests in Colombia, a new leftist government in Peru and fears that Brazilian President Jair Bolsonaro is working to undermine elections next year.
5. What’s The Benefit Of These Hikes?
In some countries, inflation is running above the central bank’s target range, so cooling prices is also tied to the policy credibility in a region with fragile institutions. Some analysts say raising interest rates will preserve the recovery by anchoring inflation expectations, shoring up credibility and offsetting what some investors perceive as excessive stimulus. And Wall Street sentiment is critical for Latin America, where sovereign bonds and currencies can plunge overnight at the first whiff of political turmoil or pendulum-swings in economic policy. In countries with political risk, accelerating inflation and economies doing well, “it’s about time that we start to take the foot off the accelerator,” says Alberto Ramos, head of Latin America research at Goldman Sachs Group Inc.
6. What Are The Risks To All The Rate Hikes?
Higher interest rates create greater debt burdens and larger fiscal deficits, which in turn can pose a threat to a long-term recovery. Rate hikes are making domestic debt more expensive at a time when the region’s debt load has spiked to the highest levels in 30 years and countries try to reel in Covid spending. That risk plays out in the decisions by central bankers: policy makers have been divided in Mexico, Colombia and Uruguay on whether to raise rates. A third wave of Covid cases from the delta variant, now circulating in the region, could derail a recovery. “There is some reluctance in the region to have a very strict tightening of monetary policy,” says Alejandro Cuadrado, head of Latin America currency strategy at BBVA in New York. “The transmission channel of monetary policy is weak in most cases.”
7. Why Don’t Rate Hikes Have An Immediate Impact In Latin America?
Latin America’s economies are notable for high levels of informal jobs — all-cash, low-wage gigs at companies that typically don’t qualify for loans. This portion of the labor force — and employers — is expected to grow even more in the recovery from the pandemic, putting more of the economy out of the formal financial system. And over half the region’s adult population didn’t have a bank account before the pandemic. With so much activity off the books, rate hikes don’t have the immediate impact in Latin America that they often do in the U.S. or Europe.
8. What Are Banks Signaling About The Next Steps?
That more rate increases are on the horizon. Brazil’s central bank already forecasts another 100 basis-point rate hike in September with Colombia following soon after. BBVA’s Cuadrado sees most Latin American central banks continuing to raise rates this year. The notable exception is Argentina, which doesn’t follow an inflation targeting system, and isn’t planning to boost rates any time soon despite 52% inflation. Policy makers in Buenos Aires worry a rate hike could actually accelerate inflation because higher interest payments would increase the amount of money in circulation.
Domestic Wheat Prices Rally As Farmers Hold Grain Back From The Market
Wheat prices for the month are surging to the highest in at least a decade, contrary to the typical decline during this period as the new harvest flows in. That may be the result of farmers holding the grain back from the market because they’re wary of making bad deals under a recent export tax.
The duty was meant to help stifle inflation, yet the annual rate is now 6.5%, the highest since 2016.
“Domestic wheat prices have rallied as farmers and internal traders are reluctant to sell, even after the new harvest, amid a formula-based export tax,” Eduard Zernin, head of the Russian Union of Grain Exporters, said on his Facebook page Aug. 17. “If current prices will be maintained for relatively long time, we can expect extra measures to stabilize them.”
Russian domestic wheat prices jumped in August to levels typically not seen this time of year, raising concerns about food price inflation and possible government reaction.
Russia, the world’s top wheat shipper, started a flat tax on wheat exports in February and switched to floating duties in June as it sought to cool food price inflation. The floating duty increased to $31.70 a ton this week, compared with $30.40 last week.
The current situation with inflation is indicative of what might come, Natalia Orlova, chief economist at Alfa-Bank in Moscow, said by phone. “If at the start of August there is no trajectory for a strong decline in prices, it is difficult to imagine that it will begin in September.”
Another area of concern is how big the new harvest will be. The U.S. Department of Agriculture said this month it expects Russian wheat production of 72.5 million tons, a 15% decline from its forecast in July. Russia’s Agriculture Ministry maintains its forecast of 81 million tons, even as some independent analysts see it lower.
The average wheat yield is running lower than last year, according to data from the Agriculture Ministry’s analytical center published on Monday.
“The fact that the forecast for the harvest was lowered is also one of the preliminary signals that inflation may not slow down as quickly as we would like to see at the turn of next year,” said Evgeny Koshelev, an analyst at Rosbank in Moscow.
Last month, the Bank of Russia delivered its biggest interest-rate hike since the 2014 ruble crisis to combat runaway inflation. It also left the door open for more increases.
The central bank’s press service said it monitors the prices as it can influence inflation expectations and consumer behavior of households. The ministry didn’t respond to a request for comment on the price increase.
The situation should normalize as the new harvest comes in, and prices should start leveling off, Zernin said.
“The wheat is not in deficit, but farmers are just afraid to make a bad bargain,” he said. “Oilseeds harvesting will start soon, pushing farmers to sell grains.”
Lumber’s Boom-Bust Cycle Sets Producers Up For Year-End Rally
Plunging lumber prices may have sent shares of producers tumbling in recent weeks, but analysts and traders say that if history is any guide, stocks are set for a rebound as the homebuilding season picks up into year-end.
Over the past 20 years, lumber prices and shares of companies from West Fraser Timber Co. and Canfor Corp. to Louisiana-Pacific Corp. have tended to slump in September before rallying into the new year, according to a Bloomberg analysis of seasonality patterns. RBC Capital Markets analyst Paul Quinn says don’t expect this go-around to be any different.
“We see a positive setup for the traditional seasonal trade, where shares will typically bottom around mid-to-late October before rallying in anticipation of the upcoming building season,” Quinn wrote in a note to clients last week. Demand for wood products is likely to rise once the homeowners return from their summer holidays and slow their spending on leisure activities, he added, citing lumber traders. Quinn’s top “deep value” picks in the sector include Canfor, Conifex Timber Inc. and Western Forest Products Inc.
down home owners boosted spending on do-it-yourself renovations and low mortgage rates spurred a building boom, catching sawmills with depleted inventories off guard. Anticipating a continued surge, producers ramped up supply and home centers stocked up aggressively, only to see demand fall back to Earth. Futures prices have fallen more than 70% in the aftermath, and lumber dealers have been forced to liquidate inventory, Quinn said.
The sudden crash has taken its toll on producers. Western Forest Products is down roughly 20% since its May peak, while Canfor, which on Wednesday said that it’s reducing operations at some of its British Columbia sawmills, has slumped over 25%. Conifex Timber, which is off more than 30% in the span, said last week it will temporarily slow production at its sawmill in Mackenzie, B.C. due to an “unprecedented collapse in lumber prices.”
Producers in British Columbia’s key interior region, where an estimated 14% of North America’s lumber comes from, are now “underwater” with regional mill cash costs around $525 to $575 per thousand board feet in the second half of 2021, Canadian Imperial Bank of Commerce analyst Hamir Patel wrote in an Aug. 19 note.
Shares of lumber producers are trading at a “meaningful discount” and the worst of the selloff is likely in the past, Quinn wrote in a separate report.
“Although lumber stocks are likely to remain under pressure until pricing starts to increase, we think that the worst of the declines are over and that it is a good time to start getting up to speed on the sector,” he added.
Costco To Raise Prices 3.5-4.5% While Also Reintroducing Buying Limits On Items Like Toilet Paper
Supply chain problems are pushing Costco to reintroduce purchase limits on key household items like bottled water and toilet paper, according to the company’s chief executive, who cited factors like port delays, driver shortages, and general “COVID disruption.”
Factors pressuring supply chains and contributing to inflation, according to Galanti, include “port delays, container shortages, COVID disruptions, shortages on various components, raw materials, and ingredients; labor cost pressures, and trucker and driver shortages—truck and driver services.”
While Costco has responded to the supply chain crunch by ramping up purchases and ordering early with Christmas items like toys, the company is also bringing back buying limits on some products, Galanti said. These include toilet paper, bottled water, paper towels, and high-demand cleaning products, though he did not specify how many items customers would be able to purchase.
Seeking to ease some of the supply pressures, Galanti said Costco has chartered three ocean vessels and leased thousands of shipping containers for use on those ships for the next year to ramp up shipments between Asia and the United States.
On inflation, Galanti spoke of various factors pressuring prices.
“Inflationary factors abound, higher labor costs, higher freight cost, higher transportation demand, along with container shortages and port delays, increased demand in certain product categories,” he said.
Higher costs of plastics and resins have led to many items in Costco’s offering—such as trash bags, plastic cups, and pet products—to go up by between 5 to 11 percent, he said.
He estimated that the overall price inflation of products Costco is selling to be in the 3.5 percent to 4.5 percent range. This is an increase from the 1 percent to 1.5 percent range he estimated in March and the 2.5 percent to 3.5 percent range he projected in May.
Galanti said Costco would bear some of those costs, but some would be passed on to consumers.
“With inflation, to the extent that there are permanent inflationary items, like freight costs, or even somewhat permanent for the next year, we can’t hold on to all those, some of that has to be passed on and it is being passed on,” he said.
Galanti also touched on the semiconductor shortage that has bedeviled the automaking industry, among others. He said the chip crunch had also impacted items in Costco’s product offering, including computers, tablets, video games, and major appliances.
These 8 Items Are About To Get More Expensive
The pandemic has slowed down significantly (thank goodness), but its effects are still impacting the way you get your groceries. This is according to Richard Galanti, chief financial officer at Costco. This week, Galanti reported on Costco’s latest earnings, blaming lags in the supply chain for impending price increases on eight of the everyday groceries you buy. We have the list.
According to CNBC, Galanti said that Costco’s prices will soon rise because “inflationary factors abound.” He continued: “These include higher labor costs, higher freight costs, higher transportation demand, along with the container shortage and port delays … increased demand in various product categories some shortages, various shortages of everything from chips to oils and chemical supplies by facilities hit by the Gulf freeze and storms and, in some cases, higher commodity prices.”
In short, which common Costco items are about hit your wallet harder? Read through to find out which 8 Costco items members are stocking up on big-time right now.
1. Paper Products
This one has been generating big buzz on social media: Costco’s paper products have been affected by a pulp shortage. The Seattle-based chain has even made some changes to the size of some popular paper products.
2. Aluminum Foil
Some Costco members know their aluminum foil lasts ages. Unfortunately, Galanti said Costco has “been seeing accelerating prices across a range of products,” and aluminum foil was one of those he listed.
Galanti reported that Costco meat prices have gone up 20% in recent weeks.
4. Plastic Products
Costco has “cited price increases,” states CNBC, “for an assortment of plastic products”—reportedly up to 8%. This may be a good time to try more sustainable types.
Soda buyers at Costco may notice a hike in these products, as well.
Costco is known for a great cheese selection, but this news could affect those burgers on the grill. Cheese was another product on Galanti’s list of Costco groceries that are about to get more expensive.
7. Rotisserie Chicken
There are lots of amazing facts about Costco’s rotisserie chicken, as many customers know. Galanti said the popular item—currently at just $4.99 for an easy dinner—could soon increase in cost.
8. Bottled Water
Just as you’re about to get thirsty this season, bottled water prices could balloon, Galanti said.
Costco has joined Home Depot in renting its own container ships to prevent delays and keep costs down as the global shipping crisis rages on.
In a call with analysts Thursday, Costco CFO Richard Galanti said the company had chartered three ships to import products from Asia to the US and Canada. This would help Costco avoid spending six times the normal price on shipping or containers through a third party, he said.
Each ship could carry between 800 and 1,000 containers at a time, he said. The company had also leased “several thousand containers for use on these ships,” he said.
Costco expected to make about 10 deliveries over the next year using these ships, accounting for about 20% of its imports from Asia, he said.
The big-box chain is among a large group of retailers grappling with an ongoing supply-chain crisis that’s causing delays and shortages.
Falling demand in the first half of 2020, followed by a surge at the back end of the year, has led to delays, port traffic jams, and blockages. A lack of containers and dock workers has made the situation worse.
At the same time, retailers are being hit by truck and driver shortages, leading to further delays and higher costs.
“As I discussed on last quarter’s call, inflationary factors abound,” Galanti said. “Higher labor costs, higher freight costs, higher transportation demand, along with container shortages and port delays. … It’s a lot of fun right now.”
Costco’s standard rollout time for new products in its stores had doubled in some cases, he said, adding that furniture, toys, computers, video games, and appliances had the biggest delays.
Costco Is Renting 3 Container Ships And ‘Several Thousand Containers’
Costco is renting its own container ships to import products from Asia to the U.S. and Canada, reportedly in an effort to sidestep the global shipping crisis and shield itself from shortages and rising costs.
Supply chains are so badly tangled that the company said it has chartered three ocean vessels for the next year to transport containers between Asia and the United States and Canada.
The complex network of ports, container vessels and trucks that moves goods around the world is still badly clogged after falling out of sync last year, and the cost of shipping is skyrocketing. Steel containers have become incredibly scarce and extremely expensive.
The situation is so severe that bigger companies are attempting to take matters into their own hands (smaller businesses, meanwhile, don’t have that luxury). Costco, which has leased several thousand containers to use on its chartered ships, said its fleet will make about 10 deliveries during 2022
Lumber Prices Stage A Late Season Rally
The gains aren’t likely the start of a wild ride like the one this past spring, analysts and executives say, but the increases show how some of this year’s surge in the price of raw materials is lingering.
Lumber prices are rising again.
Futures are up almost 40% since late August, while pricing service Random Lengths said that its framing composite index, which tracks on-the-spot sales, has added 27%. Analysts and industry executives don’t expect the gains to be the start of a wild ride like the one in spring that sent two-by-fours into orbit and then plunging back to earth.
Yet, the recent upturn shows how some of this year’s surge in the price of raw materials is lingering.
At $625.10 per thousand board feet, lumber futures are nearly as expensive as they ever were before the pandemic. Analysts say prices need to climb higher to balance supply with demand.
That could be a shock to builders and other buyers expecting market-equilibrium lumber prices to be closer to the $357 that futures averaged between 2015 and 2019.
“We think this $100 run that we’ve seen so far, that we’re not done yet,” said Paul Jannke, a lumber analyst for Forest Economic Advisors LLC. ”We do think over the next few years, on average, that prices are going to come off, but they are going to remain high relative to history,” he told clients of Canadian Imperial Bank of Commerce in a presentation this week.
This year’s lumber bubble pushed futures as high as $1,711.20 and prompted fears of runaway inflation. When it burst, investors and policy makers, including Federal Reserve Chairman Jerome Powell, pointed to plunging lumber as a sign that the soaring prices that accompanied the economic reopening were the result of kinked supply chains and would fade with distance from the clumsy restart.
At a congressional hearing Tuesday, however, Mr. Powell said that the burst of inflation this year has been broader and more persistent than anticipated because supply chains remain snarled. Lumber’s late-season climb is part of a broad rally in commodities in which natural gas prices rose 61% in the third-quarter and oat futures have been trading at record highs.
Paintmaker Sherwin-Williams Co. told investors this week to expect lower sales and profits this year due to scarcity of some materials and more expensive inputs like solvents and steel. The Cleveland company said the situation has worsened since Hurricane Ida slammed into Louisiana last month and upset operations at chemical plants and gas platforms along the Gulf Coast.
“In addition to the significant supply challenges, raw-material pricing remains highly elevated,” Chief Executive John G. Morikis told analysts Wednesday. “We continue to combat these elevated costs with pricing actions across our businesses.”
Big lumber buyers, from home builders to hardware stores and even casket makers, say they are still working through inventories of wood that were built up at high prices earlier this year.
Builders, including Lennar Corp. and Toll Brothers Inc. , say that the houses they have finished lately were built with lumber bought at highs. They say their profit margins should improve next year because the houses started now are being constructed with wood purchased since prices peaked. But the wood bills aren’t likely to be nearly as low as anticipated a few weeks ago.
Sawmills in British Columbia began curtailing output in July because the wildfires made it difficult to obtain logs and deliver lumber to customers.
Meanwhile, the cost of buying timber from the provincial government has risen sharply. The so-called stumpage price in British Columbia is determined by lumber prices months earlier. That has meant log prices have moved way up to reflect the spring surge at the same time lumber prices have declined.
As a result, many mills in one of the continent’s top lumber producing regions will make losses until log prices are reset lower next year, analysts say.
Canfor, which reduced output due to the wildfires, made deeper cuts in August, bringing all but one mill in British Columbia to about 80% of capacity. West Fraser Timber Co. , which is North America’s largest lumber producer, made its own curtailments, trimming output across its mills in Canada and the U.S. by between 5% and 10%. West Fraser blamed fires, as well as shortages of materials and labor, transportation problems and expensive logs.
Many companies, including West Fraser and Canfor, have plans to ramp up capacity in the U.S. South, where a glut of timber has made the region the most profitable place in North America to produce lumber. But those projects can take months and sometimes years to complete.
Georgia-Pacific on Wednesday said it would spend $120 million expanding and modernizing its lumber facility in Pineland, Texas, to boost capacity by about 18%. The company expects to finish late next year.
In the near term, lumber prices must rise to bring British Columbian mills back to profitability and full operating capacity, analysts say. Without robust production from Northwest Canada, demand could overwhelm dealers, who are holding less wood, as measured in months of supply, than any time in the past 20 years, according to Forest Economic Advisors.
“Over the next few months there will still be a lot of supply chain issues and dealers don’t want to get caught with low supplies,” Russ Taylor, a Vancouver wood market consultant. “We’re going to see very volatile prices.”
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