Doug Noland: Un-Anchored

Smart Bird Comment: The financial sphere is not driven by inflation, but “inflation expectations”. The Fed will say whatever it takes to attempt to manage expectations, but the market may not listen. Higher inflation pushes interest rates higher, higher interest rates will bring down stocks… and bubbles do not work in reverse. This is the risk of 2021.


A big week on the inflation front.

April CPI was reported up 0.8% versus estimates of 0.2%. And while the 4.2% y-o-y increase was partly a function of the year ago negative CPI prints, it’s worth noting CPI was up 2.1% over just the past four months. “Core” CPI increased a much stronger than expected 0.9% for the month and was up 3.0% year-over-year. Used car and truck prices surged 10.0%, with air fares up 10.2%. The CPI’s Housing component increased 0.5% for the month, while gaining only 2.6% y-o-y.

Producer Prices were also stronger than expected. At 0.6%, April’s increase was double estimates. The 6.2% y-o-y increase was above the 5.8% estimate – and the strongest price advance in the data series dating back to November 2010. Producer Prices surged a notable 3.4% over the past four months.

April Import Prices were reported up 0.7% for the month. This pushed the y-o-y price increase to 10.6%, up from March’s 7.0% – to the strongest import price inflation since October 2011. Prices for Industrial Supplies jumped another 1.7%, this following March’s 5.2% surge.

The University of Michigan consumer survey’s One-Year Inflation Expectations component jumped to 4.6% from April’s 3.4%. Inflation Expectations have not been higher since June 2008’s 5.1%. It’s worth noting WTI Crude surged to $140 back in June ‘08, as aggressive Fed rate cuts (3.25 percentage points over eight months to 2.0%) fueled myriad speculative Bubble blow-offs. This month’s UofM survey’s Five-Year Inflation Expectations jumped from 2.7% to 3.1%, the high since March 2011.

“Higher Inflation Prompts Sharp Drop in Michigan Sentiment,” read the Bloomberg headline. Unexpectedly, Consumer Sentiment dropped to 82.8 in May from April’s 88.3, the weakest reading since February. The Current Economic Conditions component sank 6.4 points to 90.8. Elsewhere, April Retail Sales badly missed estimates.

May 11 – Bloomberg (Payne Lubbers): “Optimism among U.S. small businesses rose in April to a five-month high… Still, a record 44% respondents said they were unable to fill open positions, stunting potential sales growth, the group said. Some 31% of firms said they boosted worker compensation, the largest share in more than a year. ‘Finding qualified employees remains the biggest challenge for small businesses and is slowing economic growth,’ Bill Dunkelberg, chief economist at the NFIB, said… ‘Owners are raising compensation, offering bonuses and benefits to attract the right employees.” In addition, commodities have been soaring, helping explain a 10 percentage point increase in the share of small-business owners raising prices. That was the largest reading since the 1980s…”

The Treasury five-year “breakeven inflation rate” traded up to 2.75% in Wednesday trading – the high since September 2005 – before ending the week up slightly to 2.71%.

The Treasury reported a fiscal deficit of $226 billion for the month of April, almost 10% above estimates. Washington borrowed 34 cents of every dollar spent. After seven months of the fiscal year, the deficit reached $1.932 TN, 30% ahead of comparable 2020 ($1.481 TN). Year-to-date expenditures were up 22.5%, while receipts rose 16.1%. Forty-six cents of every dollar spent so far in the fiscal year have been borrowed. Washington is on pace for back-to-back $3 TN plus annual deficits.

Curiously, 10-year Treasury yields rose a meager five bps this week to 1.63%, reversing the previous week’s drop but remaining 11 bps below the March 31st high. German 10-year bund yields surged nine bps this week to a two-year-high negative 0.13%. French yields rose nine bps to a 14-month high of 0.26%. Italian yields surged 11 bps to a 10-month high 1.07%.

It’s now only a few weeks until the ECB’s June meeting. Bloomberg headline: “ECB Officials Expect Heated June Decision on Crisis Program.” And Friday from Reuters: “ECB sets stage for crucial June decision on emergency bond buys.” Eurozone yields could certainly be rising in anticipation of an ECB taper announcement.

May 14 – Bloomberg (Catarina Saraiva): “The Federal Reserve’s policy is in a good place right now, said Cleveland Fed President Loretta Mester, while playing down signals from data that she warns will be volatile as the economy reopens… ‘I think we’re in a good place right now with our policy and we’re going to adjust it as appropriate depending on how the actual recovery progresses,’ Mester said. ‘This is not the time to be adjusting anything on policy. It really is a time for watchful waiting, seeing how the recovery evolves.’”

How could $120 billion monthly QE and zero rates be “in a good place”? At least for now, if the Fed is not concerned with inflation risk, the Treasury market will apparently not be bothered either. But I can’t help but contemplate the possibility that factors are supporting Treasury bond prices beyond Fed dovishness. Between September 2007 and March 2008, Crude prices surged from $74 to $110 (Bloomberg Commodities Index up 30% over this period), while 10-year Treasury bond yields dropped about 120 bps to 3.30%. The Bond market completely disregarded the inflationary surge, anticipating big trouble on the horizon. Is a similar dynamic at play these days? What might the bond market be sniffing out?

Chinese Credit growth slowed markedly in April. Aggregate Financing expanded $287 billion during the month, down sharply from March’s $523 billion and almost 20% below estimates. April’s growth was 40% below that from April 2020. Aggregate Financing has expanded $1.882 TN y-t-d, down 15% from comparable 2020, but up 18% from comparable 2019. Over the past 16 months, Aggregate Financing surged $7.284 TN, up 45% from the previous comparable period.

China’s New Loans expanded $228 billion, down from March’s $424 billion and about 8% below estimates. April Loans were 14% below April 2020. At $1.419 TN, y-t-d New Loan growth was 4% ahead of comparable 2020 and 34% above comparable 2019.

Chinese Consumer lending had been booming. But at $82 billion, Consumer Loans were less than half March’s $178 billion and 21% below April 2020. Yet y-t-d growth of $480 billion was still 65% ahead of comparable 2020. Outstanding Consumer Loans jumped 15.9% over the past year, 32% over two years, 55% in three years and 131% over five years.

Corporate Loan growth also slowed notably. At $117 billion, April Corporate Loans were less than half March’s $249 billion and 21% below April 2020. Year-to-date growth of $948 billion was about 13% below comparable 2020. Corporate Loans expanded 10.9% over the past year, 25% over two years, 39% in four years and 65% over five years.

China’s M2 money supply aggregate contracted $223 billion during April, this following March’s record $628 billion expansion. At 8.1%, y-o-y M2 growth was the slowest since July 2019. The $1.169 TN y-t-d growth was 30% below comparable 2020 – while 30% ahead of 2019. M2 inflated $4.28 TN, or 13.6%, over the past 16 months. M2 was up 20% in two years, 30% in three and 57% over five years.

Reported quarterly, Total Bank Assets expanded $1.528 TN during Q1 to a record $51.177 TN. This was second only to Q1 2020’s blistering $1.924 quarterly growth. Chinese Bank Assets surged $4.222 TN over the past year, or 9.0%. Bank Assets jumped 20% over two years, 29% over three years, and 58% in five years. In one of history’s great lending booms, Bank Assets have inflated 10-fold over 16 years.

One month does not a trend make. Yet Chinese officials have been pressing for slower lending, and a slowdown was apparent in April data. A system inflated by years of such incredible Credit excess will not respond well to tighter conditions. We need to be on guard for a long-overdue Chinese Credit downturn.

May 12 – Bloomberg (Rebecca Choong Wilkins and Ailing Tan): “Chinese corporations are defaulting on local bonds at the fastest pace on record, as authorities ramp up efforts to introduce more financial discipline and transparency in the world’s second-largest debt market. Firms so far this year have failed to make payments on 99.8 billion yuan ($15.5bn) of onshore bonds… While 2021 is set to be the fourth straight year the 100 billion yuan level has been topped, it previously hadn’t happened before September… Missed payments are running at a record pace this year, following the late 2020 defaults of some state-linked firms which affirmed convictions that authorities in China are increasingly willing to not bail out weak firms.”

May 14 – Bloomberg: “A sharp drop in one of China Huarong Asset Management Co.’s lightly traded onshore bonds left investors puzzled as they searched for potential catalysts. The embattled financial conglomerate’s 19 billion yuan ($2.95bn) local bond maturing in 2022 plunged by 12.4 yuan Thursday to a record low of 86.15 yuan…”

It seems we haven’t heard the last of the Huarong saga. China Huarong International CDS surged 178 bps this week to an almost three-week high of 958 bps. Beyond mounting Credit problems, Chinese officials have their own inflation worries. Chinese April PPI was reported at a stronger-than-expected 6.8% y-o-y.

May 12 – Reuters (Lusha Zhang, Kevin Yao and Tom Daly): “China will monitor changes in overseas and domestic markets and effectively cope with a fast increase in commodity prices, the state council said… China will step up coordination between monetary policy and other policies to maintain stable economic operations, the cabinet also said… Prices for commodities such as copper, coal and steelmaking raw material iron ore extended recent rallies to hit all-time highs this week on concerns a post-coronavirus pandemic demand rebound in China is outpacing supply. China is the world’s biggest market for copper, coal and iron ore and consumers face much higher costs as some analysts expect a commodities ‘super-cycle’. The cabinet did not say how it would cope with the rise in commodity prices.”

Chinese officials have been talking tightening measures. Perhaps spiking commodities prices are providing them some teeth. In the midst of spectacular global commodities price surge and inflation focus, little attention is being paid to the possibility of a momentous change in China’s monetary backdrop.

The industrial metals reversed sharply lower this week. Iron Ore dropped 2.5%, Copper 2.0%, Aluminum 3.0%, Nickel 3.0%, Zinc 2.6% and Lead 3.6%. In the agriculture commodities, Corn sank 12.1% and Wheat fell 7.2%.

China’s historic Bubble has been inflating for so long everyone assumes it will inflate indefinitely. Perhaps the Treasury market discerns Bubble fragility from China to the U.S. Friday afternoon from Bloomberg: “Dip-Buyers Report to Duty to Save Stocks From Worst Week of 2021.” While the late-week rally had traders feeling pretty good about things, the bottom line is Monday through Wednesday market action was rather ugly. It looked about as one would expect from faltering Bubbles – from tech stocks to crypto to ARK.

Unsettled by mounting inflationary pressures, the Treasury market finds peace from global Bubble fragilities. And I actually believe the Fed is on the same page. Officials will resolutely dismiss inflation risk – because they’re scared to death of collapsing Bubbles. At this point, they must believe it’s best to just let the Bubbles and manias run their course.

The Fed and market pundits stick blindly to the assertion “inflation expectations will remain well anchored” – assuring the bond market, dovish Fed policies and the great bull market are all equally well anchored. Yet this is not an environment where we should expect anything to be securely anchored.

We live in a period of acute disorder – monetary and otherwise. Society has been rocked off its foundation. The insecurity that comes with a once-in-a-century pandemic – our health, our economy, our institutions and our social cohesion. Hurricanes, floods, drought, devastating fires – the frightening uncertainties associated with global climate change. Power outages. Water shortages. Shootings. A ransomware hack that takes down a major U.S. pipeline and leaves millions fearing they won’t be able to fill their tanks. Who and what next? The Fed “printing” Trillions – seemingly blind to inflation and Bubble risks. Multi-Trillion dollar deficits. Wealth redistribution. Traditions and political institutions in disarray.

It was an unnerving week. Things seem particularly Un-Anchored.

Original Post 15 May 2021


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Categories: Perspectives