Aurelia Butler

Good morning. There are lots of stories about how turkey prices are going to be way up this Thanksgiving. That’s what I call good inflation: turkey tastes bad, and we should all eat less of it. If you disagree with this or any of the other equally correct opinions found below, email us: [email protected] and [email protected] bond market vs the punditocracyThat last US inflation report was, for lots of market observers, final proof that things are getting out of hand. Bill Dudley, former New York Fed president, wrote in Bloomberg on Monday that inflation is getting out of hand and the Fed has no good options. If the US central bank does not pull back quantitative easing more aggressively:The economy could significantly overheat, requiring the Fed to jam on the brakes, precipitating an early recession. In contrast, if the Fed were to accelerate its asset purchase taper, a “taper tantrum”, which Fed officials have spent the last year trying to avoid, would be inevitable . . . Most likely, [the dilemma] will be resolved by the Fed sitting on its hands and hoping for better news on inflation, labour market supply and inflation expectations. But as my old boss Tim Geithner was often fond of saying, “hope is not a strategy”.Speaking on Bloomberg TV on Monday, Jeffrey Lacker, a former head of the Richmond Fed, said:The reason we got inflation under control, tamed it and held it under 2 per cent was by responding with alacrity to inflation scares, little blips in the bond market . . . Three to 4 per cent [policy rates] wouldn’t surprise me in this cycle. I think [the Fed] are on track to a major policy blunder and recovering from that, realising they have waited too long, is going to cause them to of necessity raise rates sharply and try to engineer a cooling of the economy and a cooling of the labour market and that rarely turns out well . . . it’s plausible that we get to 3.5 per cent and in addition we push the economy into a recession . . . From a Larry Summers tweet thread from Monday:The Fed should signal that the primary risk is overheating and accelerate tapering of its asset purchases. Given the house-price boom, mortgage-related purchases should stop immediately . . . Excessive inflation and a sense that it was not being controlled helped elect Richard Nixon and Ronald Reagan, and risks bringing Donald Trump back to power . . . While an overheating economy is a relatively good problem to have compared to a pandemic or a financial crisis, it will metastasise and threaten prosperity and public trust unless clearly acknowledged and addressed.Not to be forgotten, Mohamed El-Erian, also on Monday:I think the Fed is losing credibility. I’ve argued that it is really important to re-establish a credible voice on inflation and this has massive institutional, political and social implications . . . I hope that the Fed will catch up with developments on the ground.All of these people may be absolutely right. But the markets, and in particular the bond market, seem to think they are absolutely wrong. The Fed funds futures market implies we are likely to get only two rate increases next year, not starting till mid-year; and the bond market is suggesting that this will be enough to bring inflation more or less to heel. And below is the Treasury yield curve. The grey caps are the added yield since mid-September, when rates began their latest rally as inflation worries tightened their grip:

The two and five have moved quite a bit. But the 10 has taken only a moderate step up, while the 30 has shrugged contemptuously. This looks like a picture burst of inflation that subsides reasonably quickly. The five-year, five-year forward inflation rate is unchanged since May, at under 2.4 per cent. As Richard Barwell, head of macro research at BNP Paribas, put it to me: [The] market does expect central banks to respond now, and the more worried the market becomes about inflation today the more hikes we price at the front end. But change in beliefs also trigger a redistribution of term premium from the back to front — if you think central banks will act today rather than put themselves far behind the curve then you need less compensation for a major correction in policy later to tame runaway inflation . . . . . . [also] growing pessimism about the medium-term global growth outlook implies lower terminal rates if a global hiking cycle ever even materialises.(“Terminal rates”, by the way, are not what Bloomberg charges its customers but rather the highest policy rate in a given rate-increase cycle). Most tellingly, perhaps, real yields have only continued to fall:

My naive understanding is that if inflation starts to get out of control, real yields have to go up, because investors want compensation for volatile future inflation. But this ain’t happening. How can the disagreement between the market and the punditocracy be resolved? I can think of four possibilities.The market just turns out to be wrong. What can you say? Happens all the time.The pundits just turn out to be wrong. “It’s not fashionable to say it now, but inflation is transitory,” David Kelly, JPMorgan Asset Management’s chief strategist, told me on Monday. “In a year’s time, inflation is going to start with a 2-handle.” He cites the outsized effect of energy prices on inflation now, the diminishing fiscal transfers, and surging production. Yes, wages and rent are going to be sticky, but that means “we are headed for a 2 per cent plus world, not the old 2 per cent minus world”. He even doubts the first rate rise will be in the middle of next year, because both inflation and growth will be falling by then, and for Fed officials “do you really want to hike just before a midterm election? What is the point of annoying the president immensely?”Another member of the (increasingly lonely) transitory crew it Matt Klein over at The Overshoot, who points out that survey data and actual purchasing patterns show that American consumers believe that high prices are temporary, making an inflation spiral unlikely. The market is not a very good indicator. The standard version of this view holds that Fed bond buying has destroyed the informational value of the yield curve. Scott DiMaggio, co-head of fixed income at AllianceBernstein, points out that the curve is also under the influence of rabid demand from international investors who, even after the cost of currency hedging, can still earn higher yields on Treasuries than they can on European or Japanese bonds. Finally, incessant buying by pension funds and insurance companies desperate to match their long-term liabilities with long-term assets means 30-year Treasuries will be expensive no matter what the US economy does. The market does not mean what we think it means. Perhaps I and a lot of other people are misreading the bond market. One might argue for example that the relatively high five-year rates and relatively low 10-year rates are consistent with a hard tightening sometime in the next year or so (this still requires the belief that the Fed funds futures market is wrong). This seems to be what Dudley thinks:The fact that the five-year, five-year TIPS break-even rate hasn’t moved up much says little about the nearer-term inflation outlook. All it means is that market participants expect that the Fed will eventually do its job and push inflation back down to 2 per cent.What does Unhedged think? It sits, shamefaced, on the fence. Forced to bet, I would say that even without a rate increase before then, headline inflation will be notably lower (3 something, say) by the middle of next year, eased down by calendar effects, car prices falling, and energy not taking another big leg up. But my confidence about this is not high.Taproot and bitcoin’s double lifeBitcoin got a protocol upgrade over the weekend called Taproot. Prices didn’t react much; the update has been pending for some time. Taproot promises a faster bitcoin network with better smart contracts (bits of code that allow for computer-executed agreements), helping to address longstanding complaints that bitcoin is hard to transact in, and therefore a lousy currency.Improvements in bitcoin’s “medium of exchange” aspect are welcome, but raise questions about its “store of value” aspect. Is bitcoin a payment system or digital gold? Both? Something else? (Jack Dorsey thinks it could bring about world peace.)David Siemer of Wave Financial, a longtime crypto insider, sees no tension between the medium-of-exchange story and the store-of-value story:Bitcoin being more like a currency actually amplifies its store of value. The biggest knock on bitcoin always was that it’s a terrible currency, meaning it’s super volatile, but also super hard to deal with [transact in].Taproot will help fix that second issue, especially in emerging markets, Siemer explained. But is the volatility of bitcoin still not a barrier to the transactional usefulness of bitcoin? Nope. “No one complains about upside volatility. Downside volatility is a real problem, but 95% of bitcoins are held at a profit.”Well, over half of circulating bitcoins were held at a loss in March 2020, during a price dip. And upside volatility does too hurt the currency use case, because no one wants to spend a rapidly appreciating asset.Crypto holders, of course, will not be disappointed if their preferred story — digital gold or digital currency — turns out to be false, so long as one of them turns out to be true and the price keeps rising. But it seems to Unhedged that the two stories, which are ill at ease, could suggest very different price outcomes. (Ethan Wu)One good readMore research from the “P-values should make you suspicious” industry. Also read Robin Wigglesworth’s nice summary of the debate. More

Cheap electricity and strong labour supply have kept Australian inflation lower than in other countries, the governor of the Reserve Bank declared on Tuesday.Addressing a group of business economists in an online webinar, Philip Lowe said price pressures in Australia were lower than in countries such as the US and the UK, with underlying inflation of 2.1 per cent in the year to the September quarter.The divergence adds weight to arguments that rapid price increases in some economies were due to supply disruptions from the Covid-19 pandemic, rather than a global shift towards high inflation.“There was a perfect storm of sorts: very strong demand for goods combined with a hit to productive capacity. The result was a sharp increase in shipping costs around the world, a fall in inventories, increased delivery times and large rises in the prices of many goods,” Lowe said.Unlike the US and the UK, where lockdowns and school closures had led to a big drop in labour supply, Australia’s JobKeeper programme had maintained the link between businesses and employees, Lowe said. Higher labour supply is helping to keep wages in Australia down.Labour force participation rose to a record high in Australia after the economy began to recover from Covid-19 lockdowns. Participation fell after the Delta variant of the virus hit the economy but the RBA thinks it will rise again to record levels.The wage-setting process in Australia includes multiyear agreements. That means they have a degree of inertia, said Lowe. The RBA expects wage growth to pick up but only gradually.“Our business liaison suggests that most businesses retain a strong cost control mindset and are seeking to use measures other than raising base wages to attract and retain staff,” said Lowe.A second factor limiting inflation in Australia is energy prices, he said, with prices trending down in recent years, partly due to increased capacity from wind and solar generation.

Electricity prices in other advanced economies have surged as their power systems struggle to meet demand — one reason for the rise in global inflation.Other dynamics pushing up inflation, such as higher oil prices, rising construction costs and shifts in consumption patterns towards durable goods, were similar in Australia to other countries.Data and forecasts suggested there would be no need to raise interest rates from 0.1 per cent during 2022, said Lowe, with lower inflation giving the RBA more leeway than other central banks.Australia has little historical experience of how the labour market works at an unemployment rate of 4 per cent, Lowe said, and there was uncertainty about how the reopening of international borders would affect the labour supply.“It is therefore possible that faster-than-expected progress continues to be made towards achieving the inflation target. If so, there would be a case to lift the cash rate before 2024,” he said.Lowe was speaking two weeks after the RBA abandoned its policy of yield curve control and allowed three-year bond yields to rise above 0.1 per cent. More

Investors are living in a “dreamland” brought on by global central banks’ decision to continue pumping up the world economy even as it has rebounded sharply from the pandemic, Bill Gross has said. Historically low interest rates and mammoth bond-buying programmes, which are only now being cautiously scaled back, have nurtured a widespread bout of financial euphoria in everything from stocks to digital assets such as “non-fungible tokens”, the founder of bond investment group Pimco told the Financial Times in an interview. “It’s dangerous,” Gross warned of accommodative central bank policy. “It’s all dreamland that’s been supported by interest rates that aren’t where they should be.” 

The US inflation rate, which was already running hotter than the Federal Reserve had been expecting, accelerated to a three-decade high of 6.2 per cent in October. Price growth is also running well ahead of target in other global economies, including the UK. That has exacerbated concerns that central banks will need to act sooner and more aggressively than previously indicated. Gross’s comments on financial exuberance echo a call from Christian Sewing, Deutsche Bank chief executive, who said on Monday that central banks should tighten monetary policy to provide “countermeasures” against surging inflation. Gross, who is now retired, said he was sceptical inflation would stay this high or accelerate further. He predicted, however, that it was likely to stay well above the Fed’s 2 per cent target for the foreseeable future.Nonetheless, Gross questioned whether the Fed and other central banks will — or even can — meaningfully tighten monetary policy to tame financial excesses and inflationary pressures because of the risk of causing market damage sufficient to imperil the economic recovery. “They can’t do much,” he said. “I think [Fed chair Jay Powell] is captive to the financial markets, and so he will gradually creep out of buying bonds, and next year he maybe gradually raises interest rates.” Despite inflation picking up pace in most leading nations as a result of disrupted supply chains and a strong economic recovery from the Covid-19 shock, the global bond market has largely remained sedate. Short-term government bond yields have shot up in recent weeks as investors have started to price in the possibility or likelihood of interest rates rises, but longer-term yields have stayed largely rooted at near record lows.“Near-term inflation readings may be intimidating to ‘inflation fighters’ . . . which could press central bankers to at least discuss a faster reaction-function versus the slower reaction-function of this year thus far,” Rick Rieder, chief investment officer for fixed income at BlackRock, said last week. “Still, it is likely that in time pandemic distortions and extreme base effects will ease,” he added. The yield on the 10-year benchmark Treasury note has nudged higher in response to vigorous US inflation data released last week, but at about 1.6 per cent it remains exceptionally low, indicating that many bond investors still think the current inflation rate is a spike that will pass eventually. But Gross — who now primarily manages the money of his own foundation — still worries about the long-term effects of the past decade’s monetary experiment with low or even negative interest rates, along with vast bond-buying programmes that now total $23tn since 2008.The extended period of low interest rates has inflicted serious pain on savers, Gross said. “One of these days, one of these years, or one of these decades, the system will collapse, because capitalism depends on savers saving and investing.”The reporter on this story can be reached on [email protected] and is on Twitter at @robinwigg More

The writer is a senior fellow at Harvard Kennedy SchoolWhen the Covid-19 pandemic hit, as China locked down and countries around the world struggled to source personal protective equipment, many wrote an obituary for China-focused globalisation. It seemed a logical view, given the economic nationalism of Donald Trump and Brexit and the US-China trade war. But there is little evidence that the pandemic has prompted companies to abandon China en masse or sparked deglobalisation. A rough metric of globalisation is the ratio of world trade to world goods. After rising significantly from 1970 until the financial crisis, this has broadly moved sideways since. Overall trade balances cannot give us granular information on supply chains or globalisation. But if companies are pulling out of overseas locations and moving back home, we might expect trade balances to shrink. The US trade deficit hit a record as imports reached an all-time high of $288.5bn in September. China’s trade surplus, meanwhile, has exceeded pre-pandemic levels.If companies are near- or onshoring, we should expect long-haul shipping routes to be less congested. The busiest trade lane in the world remains the transpacific eastbound between Asia and North America. The port of Los Angeles saw record volumes in September. Foreign direct investment flows into China should be shrinking if companies are pulling out. But China overtook the US as the top destination for new FDI last year. According to data released by China’s Ministry of Commerce, actually utilised FDI in China hit a record in 2020 and, based on figures for the first nine months of 2021, is on track to exceed that record this year. Deglobalisation should also be reflected in capital flows. According to data from the Institute of International Finance, non-resident capital exited Chinese equity markets in March 2020 as part of a broader exodus of capital from emerging markets. But since then, Chinese debt and equity markets have experienced capital inflows nearly every single month. The hard data don’t support the deglobalisation narrative. What about survey data? According to HSBC, in September six in 10 companies were either currently expanding their supply chains in China or planning to do so over the next year. The respondents were from 10 countries (excluding Japan, South Korea and Taiwan) and are all either doing business in China or expect to be. Ninety-seven per cent of companies said they planned to keep investing in China, with nearly one-fifth aiming to invest at least 25 per cent of their operating profit there. The annual China Business Report from the American Chamber of Commerce in Shanghai found similar results. Of US manufacturers in China, 72 per cent have no plans to move production out of the country in the next three years. Of the remaining 28 per cent, zero were relocating production from China to the US. Nearly 60 per cent of respondents have increased their investment in China this year. Why hasn’t deglobalisation taken hold? Companies make decisions about production based on hard calculations about their bottom line over the medium- to long-term. Building a new supply infrastructure takes considerable time and resources. Taiwan Semiconductor Manufacturing Co is building a semiconductor factory in Arizona that won’t be operational until 2024, for example. Most supply chains don’t repattern at the push of a button. It may be those decisions are already in train, but not announced. Still, foreign companies can plug into sophisticated, deep supplier networks, large and efficient ports and an able workforce in China. And while many started off using Chinese inputs for exports, they now want access to a big and rapidly growing economy. Auto parts manufacturers originally entered China to produce for their home markets, but the growth of the Chinese domestic market means that they now have reason to expand, not leave. Costs are going up in China and trade tensions with the US persist. And we don’t know how the geopolitics of China will play out. What is more likely than deglobalisation is the developing “China Plus One” strategy: keep factories in China but hedge your bets with suppliers elsewhere. FDI has been growing significantly in Thailand, Vietnam and Malaysia. There’s no doubt supply chains will shift in the aftermath of the pandemic. The just-in-time inventory system is likely to change, and China may lose some business. But globalisation of production is too well-established and makes too much business sense to reverse.  More

“The risks to the inflation forecast had changed, with the distribution of possible outcomes shifting upwards,” the RBA said in minutes of its November meeting Tuesday. Key uncertainties included the duration of global supply chain disruptions and how wages respond to very low unemployment, it said.The comment reinforces the tension between central banks and markets over the likely trajectory of inflation, with traders urging policy makers to begin tightening to head off faster price growth. Australia’s central bank, like counterparts around the world, is grappling with whether a recent acceleration in inflation is temporary or more enduring.Governor Philip Lowe has kept interest rates at 0.1% and reiterated that they will not be lifted until inflation is “sustainably” within the RBA’s 2-3% target, a goal he sees as unlikely to be met before 2024.To reach the CPI target, “the labor market will need to be tight enough to generate materially higher wages growth than at the time of the meeting,” the central bank said today. “The board will not raise the cash rate until these criteria are met, and is prepared to be patient.”The RBA abandoned its three year-yield target two weeks ago after faster-than-forecast inflation sparked a bond sell-off that sent short-term yields surging. Its dovish stance has been challenged by rate traders, emboldened by rapid Covid-19 immunization rates and an earlier-than-expected reopening of the nation’s A$2 trillion ($1.5 trillion) economy. Market pricing now imply at least three rate increases next year with a chance of a fourth hike.Lowe is due to speak at 1:30 p.m. Sydney time on “Recent Trends in Inflation.”The RBA reaffirmed its decision to continue with its A$4 billion a week bond program until mid February 2022, when it will be reviewed. This will be based on three considerations:The RBA is trying to push unemployment down toward 4% to spark faster pay gains and revive inflation. Earlier this month, it upgraded its economic forecasts, now expecting underlying inflation to hit the 2.5% mid-point of its target by end-2023. ©2021 Bloomberg L.P. More

SYDNEY (Reuters) -Australia’s central bank board still thinks it likely a rise in interest rates will not be needed until 2024 given inertia in home-grown wages and inflation, even as financial markets price a move as early as next June.Minutes of the Reserve Bank of Australia’s (RBA) November policy meeting released on Tuesday showed the bank’s board did acknowledge the risks on inflation had shift upward after a surprisingly strong reading on third-quarter consumer prices.Core inflation picked up to 2.1% and moved back into the RBA’s 2-3% target band for the first time in six years, a development the bank had not expected until 2023.”The central scenario for the economy continued to be consistent with the cash rate remaining at its current level until 2024,” the minutes showed.”However, as the risks to the inflation forecast had shifted higher, it had become possible that an earlier increase in the cash rate would be appropriate.”As a result, while the bank kept the cash rate at a record low of 0.1%, it abandoned a target for 2024 bond yields concluding it was no longer credible.Markets had already moved to price in a rate rise to 0.25% by June next year, largely reflecting inflation spikes globally and particularly the United States.Yet the board still saw reasons to expect wages and inflation in Australia to lag the global trend, a subject RBA Governor Philip Lowe is due to speak on later on Tuesday.Official data on wages for the third quarter are due on Wednesday and are forecast to show a pick up in annual growth to 2.2%, back to roughly where it was before the pandemic.Lowe has long argued that to keep inflation in the 2-3% band, wages need to expand at 3% or more, a pace not seen since 2013. Indeed, in recent years not a single industry or sector has recorded pay rises above 3%.The pandemic may have changed that for a period, with the closure of Australia’s international borders leading firms to complain of a lack of suitable labour and talk of big pay offers in some hot spot sectors such as cyber security.But with borders due to reopen soon, the government has been talking of expanding migration once again with students and farm hands first on the list. More