Without a shadow of a doubt, the theme that has pervaded the financial markets this year so far has been inflation, as in, a repeat of the 1970’s is upon us. Like I have been continually reporting, such a scenario, in the foreseeable future, is pure fantasy, having no basis on reality. Notwithstanding, the pundits on tv, the journalists and the “experts” in Wall Street and academia have been very successful in transmitting this narrative to the public. Owing to being bombarded by a barrage of stories and anecdotal evidence of rising prices, the commoners have suddenly grown watchful of the emerging inflation. This much is represented in the top graph that shows the Google searches for the word "inflation". Accordingly, the interest has been soaring like never before. Naturally, due to the data going only all the way back to 2004, you have to take this with a pinch of salt. However, it has not just been the usual suspects in the media that have pushed this narrative. As the above chart demonstrates, companies have been more vigilant inflation-wise. In comparison to last year’s Q1, the mentions of "inflation" on the earnings calls of S&P 500 companies have jacked up almost 800%. Could this mean that the CPI annual rate could reach double-digit territory, as the graph implies? Obviously not; this statistic is not indicative of anything. In fact, the CPI figures for April have already been released and the YoY rate is a mere 4.2%. Unsurprisingly, after having suffered in Q1 2020 the biggest deflationary shock since the Great Depression, it would be reasonable to assume there would not be a lot of mentions about inflation. Therefore, following that massive Covid crash, which followed a terrible year of disinflation in 2019, where the term "inflation" practically disappeared from the lexicon – as depicted by the chart that shows an almost 100% drop in mentions -, any slight increase in absolute terms would entail an enormous jump in relative ones. Looking at the next couple of charts, how can anyone believe the Pandora's box of inflation has not been opened. The writing is on the wall. Because of colossal large-scale asset purchases by, especially, the major central banks (top graph) since March 2020, the inflationary inferno is bound to be kindled. If you still have any doubts, just heed the warnings the graph above is sending. On the whole of last year, the monetary aggregate M2, which everyone thinks it represents all (or close to that) the monetary forms, denominated in dollars, in existence, mushroomed at a pace not seen since World War II. Notice what happened to the annual rate of change of consumer prices (red line) in that period; it went up... fleetingly (oh boy!). LIkewise, during WWI and the Great Inflation of the 1970's, consumer prices followed the surge in the M2 aggregate. On that account, why would this time be any different? Surely, prices are going to have to soar at least as much as the decade of the 70's. As the following chart shows, prices paid by the producers, according to the ISM Manufacturing survey, have been climbing at a rate not seen since the middle of 2008 - not a good signal. Hence, it is only a matter of time till the rising costs of production are passed on to the consumers, reverting once and for all the deflationary/disinflationary environment that has hitherto haunted the global economy. As you know, if this is not your first time here, I am just being provocative. The truth is inflation is controlled by the participants in the eurodollar system, not the central banking technocrats. Thus, proper inflation - meaning rapid growth of the money supply - will only occur insofar as banks and other credit originators perceive the conditions in the economy and the financial system are adequate for expanding credit, like they did prior to the GFC1. Before you start berating me about the quality of the governments' price statistics, which are immensely tampered and not to be trusted, I agree with you. In fact, that was the topic of my first post. In it, using the ShadowStats guidance, I uncovered the shenanigans that the bureaucrats at the Bureau of Labor Statistics (BLS) were doing to hide the true depletion of the dollar's purchasing power. In short, in the mid-1980's, the BLS began doing hedonic quality adjustments. Then, for that not being enough to keep the "inflation rate" under reasonable figures, in the 1990's, the methodology was pushed further into a substitution-based calculation, in which substitution of lower-priced and lower-quality goods in the basket is made with the intent of lowering the reported rate of inflation versus the fixed-basket measure. Be that as it may, in view of the CPI not having suffered any more changes in its methodology since the last decade of the twentieth century, we can safely compare the CPI figures of today and the naughties' ones, prior to the GFC1. Curiously, in spite of all the "money printing" by the central bankers, the CPI rates have actually been lower since then, with the most recent figures breaking the shackles (somewhat) - due to supply squeezes, mainly, and base effects too (top graph). Interestingly, before the GFC, consumers were very accurate in their expectations of inflation, as per the University of Michigan. Despite that, since then, consumers have been terrible at forecasting the BLS' rate of inflation, consistently overestimating the loss in the purchasing power; not just for the next year, but for average of the next five, albeit they have been closer in forecasting the latter one (bottom left chart). Nevertheless, the consumers' perception of economic conditions, both present and future, have been rather dreadful, as the bottom right chart portrays. So, to recap, inflation expectations are climbing, while consumers are sensing a lousy economic landscape. Certainly, "stagflationists" ears must be burning. In addition, the annual rate of the CPI soared in April, besides the supply squeeze and base effects, because the US federal government decided to pamper its electorate, sending out three rounds of stimmy checks. Undeniably, the surge in consumer demand that these handouts generated, at a time when production and transportation were being restrained or even outright halted, led to higher prices. Yet, this inflation has remaind largely contained in the realm of producers for not being able to pass the costs on to the consumers. Unfortunately for the Keynesians who have promoted these policies, they are no longer having the desired effect of triggering a consumption-led recovery. As the graph on the righ demonstrates, consumers are preferring to save a bigger chunk of this latest stimmy check in comparison with the other two. Revisiting the TIPS market and the breakeven rates like we did last week, the message coming from them remains the same. Although prices are rising, they are simply a transitory phenomenon provoked by government-imposed restrictions. Emphatically, the spread between the 5-year forward rate and the 3-year (not forward) breakeven rate (bottom chart) has been considerably negative since the beginning of the year. Despite the spread has gradually been approaching positive territory, on account of the 5-year forward has been climbing a bit, implying higher future expectations of inflation, they are still very subdued relatively to historical standards. The fact that the real yields are close to or at all-time lows tells everything you need to know about the sentiment of those in the financial system. To cap it all off, even though the financial media and FinTwit have been ridden with chatter about the upcoming QE tapper by the Fed, we shall resist the pressures of the echo chamber, remain intelectually honest and guide ourselves only on what is fundamental, tuning out all the noise. In spite of being a market-based indication, Fed funds futures are part of the noise, as the graph below shows. Even if they are right, they are merely suggesting that by the end of 2023 the Fed funds rate will be half a percent. That is still awful, being just a little bit better than the absolute worst experienced last year. In conclusion, do not get swindled and carried away by the putative experts and the overload of articles and commentary on the brewing inflation. These people do not understand how the monetary and financial system works, owing to believing the central banks are exactly that, playing a pivotal role in the expansion of money and, more importantly, in the direction of the economy.
In a nutshell, the system evolved, but the experts did not; the eurodollar regime completely changed the way credit is formed and provided, throwing all prior conceptions of financial intermediation to oblivion, and still these fools, both the "stagflationists" and the mainstream economists and central bankers, are absolutely unaware of the implications of such monetary revolution. Regardless of such stubborness, the eurodollar system remains in place, albeit languishing and awaiting for its replacement. In view of not having any new setup ready and standing by, though there may be some in the making (e.g. DeFi and CBDC), we are going to have to wait awhile for what will hopefully be an upgrade - better pull up a chair. In the meantime, try to knock some sense into their heads, despite how hard that may be and how closed-minded they are.
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In the midst of all the kerfuffle around the recovery (or lack of it) coming from the financial media, Wall Street analysts and FinTwit luminaries, despite disagreeing profoundly on the soundness of the recovery, if there is actually one, these enlightened clairvoyants assert in unison that high inflation, or even hyperinflation, is on the cards. Whether it is of the Great Moderation kind or of the Great Inflation sort, the global economy, having been infested by deflationary/disinflationary disease since the GFC1 (2007-08), is going to see inflation make a comeback. As a matter of fact, we do not have to wait any longer. For the last six months, though mainly since this year broke out, prices for all sorts of goods have skyrocketed. No other market/sector has personified this belief more clearly than commodities . From lumber to corn and from copper to steel, all eyes are on commodities. Yet, there seems to be some markets, very important ones, that are oblivious to these developments. In view of not being necessary to inspect each and everyone of the markets of the commodities' domain, it suffices to analyse it in broad terms. Having soared more than 50% since the 2020 GFC2's trough, the Bloomberg Commodity Index (BCI; below graph) seems unstoppable in its ascent to the moon. Obviously, reaching a more-than-five year high, surpassing the apex of the eurodollar reflation #3 (as Jeff Snider calls it) in 2018, it clearly indicates the (global) economy is booming. Notwithstanding, is it that obvious though? You know where I am going with this. On March 1, I presented my refutation of the "commodities supercycle" that several analysts have been clamoring about. Therefore, I am not going to dwell on it here. Succinctly, the rise in commodities' prices were triggered by disturbances in production and in supply chains, which were caused by the corona-phobia-fuelled restrictions and shutdowns, as well as the various drops of "helicopter money", predominantly in the US, that allowed consumers to splurge far more than they would otherwise. Owing to most of the service sector being shutdown, consumers directed their "stimmy" checks towards goods, exarcebating the constraints in production and supply chains. By zooming out on the BCI (below chart), you can see that commodities have just escaped its historic bottom, even though this index still remains at a historically depressed level. This is surprising, of course, considering all the assertive prattle that comes out of your tv and phone screens. Perhaps, they only show and examine the graphs of commodities' prices that will tilt yours and the public's perceptions to their camp (the inflationists), ignoring those pesky ones that refuse to comply with the inflation and the supercycle narratives. In spite of being true that most commodities are reaching multi-year highs or even all-time highs, with lumber being the epitome of this climb, the overall picture looks as dire as it were before the kung-flu came to light. Albeit, commodities are currently hinting at better conditions, both present and future, than they were last year. Still, this does not excuse opening the champagne. To be fair, most commentators on the inflation camp do not view this as a good circumstance. In lieu of interpreting the increase in the prices of commodities, and of goods in general, as a sign of a burgeoning economy, quickly recovering from the government-imposed depression, they have the discernement to recognise, through other data points, the economy is still in bad shape and, consequently, they do not foresee the economic malaise to pass anytime soon. In other words, they are expecting a period of stagflation, like the Great Inflation of the 1960's and 70's. On the one hand, you have economists and central bankers that maintain the greater pace of price surges are temporary, being ultimately curbed by the still weak labour market and high uncertainty. Nevertheless, they contend that as soon as the economy reopens completely and everyone gets their vaccine jabs, due to the fiscal and monetary "stimuli", the economic activity will fully recover and possibly even "roar" like the 1920's. On the other hand, the "stagflationists" have the perspicacity to know that growth and progress do not arise from government decree and central planning, but from entrepreneurs in a free-market system. Despite that, they are in error when they assume central banks are able to "print" money - in the current framework that is not possible (eurodollar system) - and that the markets are going to, sometime in the future, reject the low-yielding government bonds (and notes and bills), punishing their profligacy and recklessness. Hence, in this scenario, central banks have to perform their lender of last resort duties and buy the debt securities issued by their respective governments, expanding the money supply as a side effect. In the end, an inflationary spiral will emerge. What these two stars of the FinTwit are saying above is exactly that. Although prices are rising, the central bankers have to downplay it so as to excuse their "accommodative" policies and keep on doing them. In addition, the central bankers resort to manipulative techniques, the so-called Fed speak, to prevent the public from thinking that the rising cost of living is not their fault. Instead, they defend themselves affirming the pandemic is the culprit. Just look at what happened this week, Janet Yellen apparently told the truth about the need for rates increases in order to fight the "overheating" economy. As a result, stocks plunged on these remarks. Once she realised the errors in her ways, she backedtracked the next day and stocks rallied, proving that stocks, the whole financial system and, thus, the economy are proped up by central banks' and governments' largesse, In case they remove the punch bowl, the entire house of cards collapses. Naturally, though it pains me to admit, I agree with the central bankers on this particular issue (just to be perfectly clear). In spite of being true that the annual price variations in both the baskets of consumer and producer goods (the CPI and PPI, respectively) have risen, especially in the latter cohort, closing in on the central banks' target levels, the figures for the last couple of months (February and March) were and the next couple of ones will still be greatly dictated by base effects. Be that as it may, consumers have been suffering the brunt of the soaring costs in the grocery stores, the petrol stations, the car dealers and so on. Because of supply shortages, there has been some companies in the consumer staples sector, such as Colgate-Palmolive, Nestlé and Procter & Gamble that confessed the need to raise their products' prices. However, insofar as credit origination remains in the doldrums, the inflationary inferno will not be kindled. To make long story short, revisiting the March 23 post, I raised the question that "since the supply squeeze is squeezing producers' margins of profit, how is this conducive for them to hire?" I concluded that "due to shrinking margins, they will pass part of the cost on to retailers and these, in turn, will pass it to consumers afterwards. However, in view of the unreliable income source for most consumers, these are not going to totally spend their stimmy checks. Thus, retailers and producers and the rest of the supply chain participants are going to be the ones to absorb the costs entirely. Unsurprisingly, a lot of them are not going to manage this squeeze and will certainly be wiped out." Furthermore, I claimed that the government stipends are interfering with the normal functioning of the labour market, discouraging former workers, distinctly low-skilled, from rejoining the labour force and getting a job. As a result, the recovery processes of the bust phase are precluded on account of "the swift adjustment of the price and profit system" being restrained. As the following charts demonstrate, the bond market is ostensibly agreeing with my assessment. Despite shooting up steeply for a couple of months or so, the reflation in bonds, chiefly outside of the US, has been suggesting curiously since the FedWire disruptions in late February that the perceptions about future conditions have stopped improving. In fact, their fall since then indicates that those perceptions have deteriorated. Undeniably, present and near-term conditions, as implied by the T-bills and the 2-year note too, continue to be dreadful. Only in the middle of this decade will conditions start to ameliorate and by the end of it will we get to the pre-pandemic circumstances. None of this is good, merely better than the absolute worst experienced last year. By the same token, the TIPS market - Treasury Inflation-Protected Securities - tells a very similar story, though an even more lugubrious one. On the left graph, the inverted breakeven rates portray the temporary (higher) inflation provoked by the supply squeeze. Notice how market participants are anticipating "normal" levels of inflation, around the magnitudes of the reflation #3, in the long-term, as expressed by the 5-year forward inflation rate. Notwithstanding, the graph on the right of the UST real yields is what paints a tremendously dismal picture. The demand for the safest financial instruments is so elevated that they do not mind seeing their returns being completely destroyed by the loss in the US dollar's purchasing power, not even for the next thirty years. Astonishingly, the (global) bond market appears to be absolutely unaware of the economic and inflation prospects that the most prominent economists and analysts are projecting. Alternatively, they are aware but, due to being so obstinate, refuse to accept the truth postulated by those astute and gifted experts. If not these reasons, then what? Are bonds deaf? Those are the only logical explanations, right? Surely, the reason has to be at least one of these if they refuse to comply with the echo chamber. While we are on the subject, can someone also reprimand gold for not following the directives. Clearly, rising gold prices are a sign of growing uncertainty in the stability and health of the financial system and the economy in general. Despite popular belief, the current gold price and its trajectory are signaling the persistent deflationary/disinflationary environment is not fading, even though those in the inflation camp take this as an indication of escalating inflation expectations. That is not to say that in a truly inflationary inferno gold price does not shoot up or even drops. Simply put, gold prices climb whenever there are imbalances in the monetary system, either inclined to the inflation or the deflation sides. Therefore, on account of deflation pervading the economy (ever since the GFC1) gold is currently running counter to the inflation and the recovery narratives. In conclusion, even if bonds are deaf that is totally irrelevant. Just like the genius Beethoven did not need to hear in order to compose the greatest musical masterpieces, the bond market can afford to ignore the cacophony coming out of orthodox-and-textbook-ridden financial media, concentrating solely on the conditions of the shadow eurodollar regime, and produce the most ingenious judgements of what is on the horizon and beyond.
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AuthorDaniel Gomes Luís Archives
March 2024
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