INFLATION!?
In today’s Bloomberg’s opinion pages, John Authers publishes two articles:
(…) These numbers offer perhaps the greatest support for the case that inflation is a near and present danger. All are way above their ranges for the last decade. (…) This could be transitory but, if so, the numbers need to come down soon.
Rising commodity prices represent exactly the kind of inflation that can attack living standards. But, given the economic collapse a year ago and the rush by speculators to get a leveraged play on the rebound, they don’t give firm evidence of inflation that is more than transitory. Metals prices are about 6% below their May peak, while energy prices have also dropped by about 6% as the OPEC+ cartel tries to sort out its problems; it’s not at all clear the latter are locked into an inflationary expansion. One increasingly ominous warning sign comes from the Commodities Research Board raw industrials index, which covers basic commodities that aren’t in the futures market. In theory, these prices should be driven by supply-and-demand dynamics in the real world, not by ebbs and flows of emotion in the markets. The index has gained more than 50% in a year and is nearing an all-time high.
Wage inflation is a crucial driver of inflation and, from the official data, it appears to be under control despite a number of factors that would normally drive salaries and wages upwards. Most measures of wage inflation are running below their average for the last five years, with the Atlanta Fed putting overall wage growth at 3.2%. Yet, job vacancies are at an all-time record, while small businesses complain that they have never found it harder to recruit workers. This suggests a problem with skill mismatches coming out of the recession. At the same time, while average hourly earnings have been quite variable over the last few months, the latest number shows them increasing at the fastest rate since 2009. The ongoing wage tracker kept by the Atlanta Fed shows that wage inflation for low-skilled workers has reached 3.6%, close to its highest since the global financial crisis. The National Federation of Independent Business finds the highest proportion of its members raising pay since they started asking the question in 1984.
Broadly, the consensus is that the Fed, like other central banks, will get what it wants. The Fed is forecasting Core PCE (personal consumption expenditure) of 3% for this year but expects it to decline to 2% in 2023; in other words, it will be transitory. The experts are less anxious for now and think it will reach 2.5% this year and decline in the two following years — more or less perfect for the Fed, which is prepared to let inflation “run hot.” German inflation, after a bobble this year, is expected to fall back to 1.7% in 2023; there’s no sign of a new reflationary cycle there or in Japan, or even China. Whatever markets say, the experts are still more worried about deflation.
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Markets Are No Longer Worried About Inflation The bad news is they are now fretting about the post-pandemic recovery.
The good news, if the market is to be believed, is that we can forget about the inflation scare. The bad news is that it might also be time to abandon hopes for a strong reopening and economic recovery from the pandemic.
Monday saw the worst day in global stock markets in some months, driven by some combination of worrying headlines about Covid, and news of intensifying rancor in the economic relationship between China and the U.S. But it’s the shift in bond markets that is most important. Bond markets make the most direct judgments on inflation, and those judgments can be self-fulfilling. (…)
As far as the bond market is concerned, the inflationary picture is actually less worrying than it has been for most of the last 10 years. (…)
Two key bond market measures are now below their mean for the last decade (a period when for most of the time deflation was a greater concern than inflation). First, the yield curve (the gap between 10- and two-year bond yields) has dropped below 100 basis points for the first time since February. Generally, the more investors expect inflation to rise in future, the steeper the curve they will demand; in other words, the gap between long- and short-dated yields will widen. A flattening yield curve is a sign of concern about growth, and lack of concern about inflation. (…)
Second, the 5-year, 5-year breakeven, which measures the expected average rate of inflation for the five years starting five years hence, or 2026 to 2031 at this point, has dropped to a fresh low; it is far below its standard level in the early years of the post-crisis decade. Crucially, this is the Federal Reserve’s favored measure of inflation expectations.
Effectively, this means the bond market is saying that inflation isn’t an issue at all. It’s no more of a concern than it has been for most of the last decade, and the pervasive problem during that period has been the lack of growth and inflation.
(…) business and consumer surveys shows that businesses are already convinced they are in the grip of cost inflation, while consumers are bracing for price increases ahead. These are based on solid empirical questions. And if businesses and consumers are thinking this way, they are likely to act accordingly — which will drive higher inflation. Meanwhile, the pale stripe for economists’ estimates shows that the forecasting profession, which also has big influence over companies’ and governments’ plans and can easily come up with self-fulfilling prophecies, is convinced there’s nothing to worry about. (…)
For a number of reasons, the case for inflation in the short term has weakened in the last few weeks. The risk of more Covid shutdowns and a Chinese slowdown will have that effect. The indicators capture this. But the point of the heat map discipline is to force us to pay attention to all the relevant developments. And the RIND index, combined with the complaints about higher costs from corporate executives in surveys and in earnings calls, shows that there are some genuine inflationary pressures out there. If the effects are transitory, we should expect to see the RIND index, and the business surveys, calm down over the weeks and months ahead. If they don’t (perhaps because Covid doesn’t return as fiercely as feared), then we should prepare for another dose of inflation angst. Keep watching this space.
The RIND index “includes a range of basic materials that aren’t covered by the futures market. The constituents have an “old school” feel about them: Industrials include burlap, copper scrap, cotton, hides, lead scrap, print cloth, rosin, rubber, steel scrap, tallow, tin, wool tops and zinc; while foodstuffs include butter, cocoa beans, corn, cottonseed oil, hogs, lard, steers, sugar and wheat.” Here’s the RIND chart, courtesy of Ed Yardeni:
This index was deflating since mid-2018 but has bounced back furiously since its pandemic trough and is now 16% above its 2018 high. No wonder executives are complaining about their rising costs. The ever useful Ed Yardeni happens to calculate price deflators for business sales. Some numbers from their pre-pandemic levels:
- All manufacturing and trade: +5.7%
- Manufacturing industries: +8.0%
- Wholesale industries: +12.0%
- Retail industries: +3.2%
Another illustration of the cost-push being gradually passed on:
The cost squeeze is the worst since at least 2005 and is only offset, so far, by the strength in demand and revenues and clients willingness to pay up.
Business surveys reflect the real world. The Prices Paid index is highly correlated to the PPI: Final Demand…
…itself being highly correlated with the CPI:
Ed Yardeni has this convenient wrap-up chart which suggests “transitory” is not underway just yet.
OPEC Gives Shale an Opening With less oil-market drama, prices fall again and U.S. producers have an opportunity
(…) Even after falling below $70, the U.S. crude-oil benchmark is roughly $20 higher than what it takes for a typical shale driller to profitably drill a new well. Producers also have been quickly returning to pre-drilled wells that can be brought online quickly: There were 6,252 drilled but uncompleted wells in seven major tight oil and shale natural-gas basins as of June, a 30% decline from a year earlier, according to the U.S. Energy Information Administration. U.S. oil inventories have fallen to the steepest seasonal deficit compared with the five-year average since 2003, according to RBC Capital Markets. (…)
Goldman Sachs’ view is that U.S. shale producers’ new found discipline (?) has been reinforced by yesterday’s sell-off which
(…) was equivalent to lowering 2H21 demand expectations by 2 mb/d, assuming no OPEC+ supply offset, as well as a 1mb/d revision to medium term demand. Our bottom-up estimate of the impact that a Delta wave could have on global demand – based on the second wave in Europe last winter and the recent one in India – instead points to a potential 1 mb/d hit for only a couple months (by which point cases should recede) (…).
In addition, we believe that non-OPEC+ production outside of North America will surprise consensus to the downside in coming months (our forecasts are 0.5 mb/d below the IEA’s over 2H21). The recent reflation equity unwind, OPEC’s guidance for higher baseline and the oil sell-off should all further reinforce shale producers’ discipline. Finally, progress on the US reaching an agreement with Iran has stalled, creating risks that the potential ramp-up in Iran exports is later than our October base-case. (…)
Importantly, the starting point remains a market in a large deficit of c.2 mb/d by our latest calculations, with demand currently at 98.5-99 mb/d, resilient so far to the Delta threat and with the recoveries in global jet and Indian demand in fact both surprising to the upside.
If rig count is any indication of producers’ discipline, there were 1,108 rigs operating on U.S. land in February 2020 when WTI prices were gyrating around $55/bbl.. There are now 806 active rigs.
Oil men inherently want to drill and produce so any discipline needs to come from investors who fund the exploration and production budgets. Between 1993 and 2015, the ROEs of public O&G producers roughly fluctuated between 5% and 25%. They actually peaked in 2006 at 27% and have dropped almost straight line since. ROEs went negative (-4%) in 2016 after oil prices collapsed from the $100s/bbl to below $50. They peaked around 10% in 2019 with prices in the $60-75 range and went negative again in 2020.
Since then, costs have gone up (steel, labor, environmental) and leverage has declined, suggesting high hurdles before getting back to the 10% ROE range in the current price environment. Until the industry demonstrates that it can provide adequate risk-adjusted returns to its investors, capital is likely to remain tight.
- Shale executives receive bumper pay packets despite dismal returns Investors sour on industry after a decade of profligate spending and debt-fuelled drilling
U.S. Home Builders Index Eases Further in July
The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo declined 1.2% (+11.1% y/y) during July to 80 from 81 in June. An improvement to 82 was expected in the INFORMA Global Markets survey. The seasonally-adjusted index was 11.1% below the record high reached in November 2020. Over the past 15 years, there has been a 65% correlation between the y/y change in the home builders index and the y/y change in new plus existing home sales.
Performance amongst the composite index’s three sub-series was mixed this month. The index of present sales conditions fell 1.1% (+10.3% y/y) to 86 from an upwardly revised 87. The level was 10.4% below last November’s record high of 96. Conversely, the index of expected sales over the next six months rose 2.5% (+8.0% y/y) to 81 and recovered its June decline. The index measuring traffic of prospective buyers weakened 8.5% (+14.0% y/y) to 65, the lowest level since August of last year. The index was 15.6% below the cycle high of 77 in November 2020.
Most regional index reading fell this month. The index for the Northeast fell 2.7% (+2.9% y/y), down for the fifth straight month. The index for the South dropped 2.4% (+15.3% y/y) and was 7.8% below the November high. The index for the West declined 2.3% (+5.0% y/y) to the lowest level in twelve months. To the upside, the index for the Midwest improved 1.4% (+2.9% y/y) and recovered its June decline. These regional series begin in December 2004.
Traffic remains high:
Slow traffic there:
Axios-Ipsos: Refusers won’t budge
Most Americans who still aren’t vaccinated say that nothing — not their own doctor administering it, a favorite celebrity’s endorsement or even paid time off — is likely to make them get the shot, Axios managing editor Margaret Talev writes from the Axios/Ipsos Coronavirus Index. (…) 30% of U.S. adults in our national survey (total: 1,048) said they haven’t yet gotten the COVID-19 vaccine. Half of them were a hard “no,” saying they’re “not at all likely” to take it.
TECHNICALS WATCH
Yesterday’s decline was broad and on heavy volume. The S&P 500 index closed just above its 50dma and its equal-weighted clone right on its 100dma. The S&P 600 Small Caps and the Russell 2000 seem to be aiming at their 200dma, 4.3% and 2.3% lower respectively. The NDX is still 3.6% above its 50dma, 10% above its 200dma.