Good Thursday AM,
After a week of gains including Monday, Tuesday seemed to hit the pause button on the mini bond rally, which took the 10-yr yield down from 1.43% to 1.19%. Both Tuesday and Wednesday had bonds under some pressure mostly as stocks regained their losses. In those two days, we gave back about half of those gains taking us right to a line in the sand of 1.295 on the 10-yr (the line in the sand is resistance or support depending on if your glass is half full or empty this AM). Let’s call it resistance as the 10-yr resisted going higher. Some bond friendly news today with unemployment claims jumping a bit as well as some dovish comments from the ECB (yes Europe still plays a part in our markets) and voila, the 10-yr is back to 1.23% today. Mortgage bonds are not doing as well yet, but I am confident they will fill in the gap. At this point I anticipate being range bound with a slight technical bias to the upside of the range (higher price, lower yields), until we start seeing next week’s news. Next week is the biggest news week of the quarter, as we get the fresh GDP numbers from last quarter, as well as lots of consumption expenditure and price numbers. Personal consumption expenses is the inflation metrics that the Fed most closely watches. Let’s hope we begin seeing signs of inflation cooling, although we may still see another month or two of elevated numbers. Additionally, Wednesday we have a Fed policy statement where whispers of dialogue of bond purchase reductions are floating around (yes, people are talking about the possibility of talking but none the less, that would be bad for rates).
The WSJ shared some deeper insight into inflation and its impact. It is on point, other than the calculation of real wage growth adjusted for inflation is more a snapshot in time, which will reverse quickly (in the next 60 days as inflation wanes, supply chains open, and the stimulus ends).
Good Inflation vs. Bad Inflation
There are two kinds of inflation. One results from demand growing faster than the economy’s productive capacity, causing the economy to overheat. Call that good inflation, because it is usually linked to a stronger economy. By contrast, bad inflation results from constricted supply which curtails output, driving up prices and eroding incomes, leading to a weaker economy. The U.S. is now experiencing several supply shocks at once, collectively throwing up a roadblock to what should be a powerful post-pandemic recovery. The most pronounced problems are in housing and autos. Both usually lead recoveries as they respond to pent-up demand and low interest rates. This time, that demand is colliding with severely constrained supply, Greg Ip writes.
Where labor shortages are the problem, the beneficiaries have been workers. This isn’t unalloyed positive, though: Higher wages for some workers are borne by higher prices paid by most others, as companies pass those costs along to customers. Adjusted for inflation, wages are down 2%.
The Federal Reserve’s tools to combat higher inflation, namely higher interest rates, work by cooling demand. They are useless when the problem is restricted supply. In fact, raising rates in the face of a supply shock could aggravate the economic damage. The best hope for the Fed and consumers is that higher prices do what they have reliably done in the past, which is to bring forth more supply.
Please remain safe and healthy, make today great!
