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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March 2024
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