Is Inflation Dead or Simply Hibernating?
The number of US Covid infections reached 80’000 last Friday, setting a fresh record (with the number of hospitalized patients up 40% last month) as the virus further spread from metropolitan areas through rural America.
Numbers in Europe were no better of course but better advertised, including with some excessively depressing (ignoring the link between the economy and confidence) discourse of French Prime Minister.
Roche’s CEO, S. Schwan, warned, adding to the chorus of drug industry leaders that “it is completely unrealistic to expect a covid vaccine to be widely available by year end, and that most people probably won’t have access to a shot until H2 2021.”
Also dampening sentiment on tech last week was the US suing Google accusing it to illegally use its power to hobble rivals.
The odds of voting stimulus legislation ahead of the elections also dropped which was pure political jockeying as the odds of a very large stimulus coming just after the elections are closer to 100% and the stimulus numbers quite staggering. The next fiscal bridge could come as large as USD2.5trn (12% of GDP), with another infrastructure bill of USD2trn, to be decided shortly thereafter.
MMT is at our doorstep and it will be facilitated in a not distant future by the introduction of central bank digital currencies (China came first with the experimentation a couple of weeks ago) as central banks seek to bypass banks too reluctant to lend.
This avalanche of actual or expected supply pushed yields higher last week, with 10-year yields rising 9bps. Perhaps, it was some bond vigilantes, waking up to the idea that all this debt monetization will translate into excessive inflationary slippage.
Claudio Borio, the BIS Chief Economist voiced thinly veiled concerns, asking whether inflation is dead or simply hibernating. His answer to the question (starting on 13’30’’ of the linked video) proposed a short term and long-term picture.
Over the short term, Claudio Borio expects the forces of globalization, technological change (the latter being accelerated by Covid) and remaining excess capacity to keep inflation well contained but cautions over the long term (with no timestamp as the timing of what long term means will be “policy” dependent), that the environment could start resembling the 70’s if the same several inflation inducing mechanisms that were in place then became today’s reality.
Those risks include an accelerating de-globalization, a rapid increase of the role of government into the economy (which would lead to a lasting decline in productivity and erode monetary policy maneuver), a rapid increase in government debt (that would constitute an incentive to generate inflation to deflate debt away), financial repression (forcing rates well below their natural equilibrium level) and a political environment (Trump’ Fed bashing and interference was erected as policy of his 4 year Presidency so far and had a distinct impact on the direction and extent of the interest rate shift) that would be more unfavorable to Central Bank’s independence. With the cautionary attitude suitable to a central banker, this presentation was a friendly warning that inflation is indeed not dead and rather hibernating. It is only too obvious that all the pieces of the puzzle for a rekindling of inflation are setting themselves or are already in place.
Another interesting article debunking the hypothesis of central bank neutrality (with implications for what is suggested above) can be found here.
The optimistic view of the world last week came from an economic recovery that seemed to exceed expectations and still resilient financial markets.
On the (geo)political side, Lebanese did not know whether they should cry or laugh as the return of Saad Hariri as Prime Minister ended hopes of a new and less self-serving regime in Lebanon. At the same time, there was a sense that Mr. Hariri could be the only one able to get the job done, when ISIS is eying Lebanon as a promising territory for its terrorist activities.
Over the past week, the S&P500 dropped -0,8% (7,1% YTD) while the Nasdaq100 shed -2,0% (33,7% YTD), underperforming. The US small cap index dropped -0,4% (-2,1% YTD).
Cboe Volatility Index rose 4,2% (104,0% YTD) to 28,11.
The Eurostoxx50 dropped -0,7% (-13,3%), outperforming the S&P500 by 0,2%.
Diversified EM equities (VWO) gained 1,3% (1,5%), outperforming the S&P500 by 2,2%.
Dollar weakness returned as the Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies dropped -0,9% (-3,4%) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) gained 0,6% (-0,1%). As we suggested repeatedly already, an important implication of the Federal Reserve QE determination could translate into a much weaker USD down the road, all the more so because the US is unlikely to tolerate for much longer the structurally large current deficits held with Europe.
10Y US Treasuries underperformed with yields rising 11bps (-107bps) to 0,85%. 10Y Bunds climbed 4bps (-38bps) to -0,57%. 10Y Italian BTPs underperformed climbing 11bps (-61bps) to 0,80%.
US High Yield (HY) Average Spread over Treasuries dropped -6bps (133bps) to 4,69%. US Investment Grade Average OAS dropped -3bps (31bps) to 1,32%.
In European credit markets, EUR 5Y Senior Financial Spread climbed 2bps (22bps) to 0,74%.
Gold ended mostly unchanged, adding 0,2% (25,4%) while Silver rallied 2,0% (38,1%). Major Gold Mines (GDX) dropped by -2,8% (33,8%).
Goldman Sachs Commodity Index dropped -0,5% (-27,4%). WTI Crude dropped -0,7% (-33,5%). The OPC+ warned last week of a “precarious” outlook as a resurgent coronavirus hurts oil demand, hinting at a possible change of policy next month (to prevent an automatic 2mbd increase in production from January). In the meantime, wild weather continued to wreak havoc on crops around the world, sending their prices higher.
Over the week end…
Ø Overnight, futures dropped (S&P-19 points) as the odds of blue wave (whereby the Dems would also take control of the Senate) tumbled to 51% (from 60%). It delivered another warning that it is (way) too early for Democrats to declare victory and that we could also still get a contested election (considered as the worst case for financial assets). Dip buyers are still circling around but the speculative positioning of speculators (notably on the Nasdaq) is already more decisively long now.
Have a nice week ahead and stay safe.
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Marc Bentin, BentinPartner GmbH
Founder, Chief Investment Officer
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