Doug Noland: Inflation Watch

August Personal Consumption Expenditures (PCE) inflation rose to 4.3% y-o-y, the largest gain in 30 years. The S&P CoreLogic National Composite Home Price Index posted a 19.7% y-o-y gain in July – the strongest housing inflation in data back to 1987. Zumper data show national apartment (two-bedroom) rent inflated 13.1% y-o-y, with Zillow national rental prices rising 11.5%. The Bloomberg Commodities Index ended the week with a year-over-year rise of 44.6%. A benchmark United Nations food index inflated 33% over the past year. University of Michigan consumer one-year inflation expectations were down slightly from July’s high to 4.6%, near a 13-year high – and only 0.5% below 40-year highs. Forecasts have September y-o-y consumer price inflation (CPI) at 5.3%, near the high since 1990.

We’ll begin with a Chair Powell comment from his September 22nd press conference:

If you look at the last two or three years before the pandemic hit, you saw, after a lot of long progress, you saw a really strong labor market. And you saw wages at the low end moving up faster than everywhere else. Something that’s great to see. We also saw the lowest unemployment rates for minorities… We saw a really, really healthy set of dynamics. And, by the way, we also — there was no reason why it couldn’t continue. There were no imbalances in the economy, and then along came the pandemic. We were not, there was nothing in the economy that looked like a buildup of imbalances that could cause a recession. So, I was very much thinking that the country would really benefit from a few more years of this. It would have been — so we’re all quite eager to get back to that.

This is somewhat confounding. If there were “no imbalances in the economy,” why then did the Fed resume QE in September 2019 – months ahead of the pandemic (with markets near all-time highs and unemployment at 50-year lows)? Federal Reserve Assets have ballooned $4.678 TN over the past two years (107 weeks), of which about $200 billion occurred prior to the Fed’s March 2020 crisis ramp up.

There were clearly worsening fragilities in market structure. It’s a key analytical point that the return of QE was in response to market “imbalances” – most notably instability in the “repo” market, which had clear potential to erupt as a catalyst to prick U.S. and global Bubbles. Recall also that U.S. “repo” market disorder followed on the heels of Chinese money market instability. Reenergized U.S., Chinese and global Bubbles could not have been more vulnerable heading into the pandemic. Their near implosions unleashed global monetary stimulus without precedent.

September 28 – Bloomberg: “China’s central bank governor said quantitative easing implemented by global peers can be damaging over the long term and vowed to keep policy normal for as long as possible. Central banks should try their best to avoid asset purchases because in the long run they will ‘damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard,’ People’s Bank of China’s Governor Yi Gang said… When central banks have to purchase assets, the programs should be in proportion to the size of the market’s trouble, Yi said. The interest rate in some economies have approached or even dipped below zero, he said. ‘China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,’ the governor said.”

I agree with Governor Yi’s astute assessment that QE will “damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard.” As for “China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,” it has me pondering whether the PBOC fully comprehends the scope of the crisis they face.

September 28 – Bloomberg: “China’s central bank injected liquidity into the financial system for a ninth day in the longest run since December as it sought to meet a surge in seasonal demand for cash. The People’s Bank of China pumped in 100 billion yuan ($15.5bn) of cash with 14-day reverse repurchase agreements, resulting in a net injection of 40 billion yuan. The move may also have been aimed at calming jitters fueled by China Evergrande Group’s debt crisis… The central bank has added a total net 750 billion yuan via open market operations since Sept. 17.”

The PBOC injected over $100 billion into China’s financial system in nine days. This no doubt helped stabilize Chinese securities markets, including the increasingly unstable corporate debt market. It also hints at the scope of Chinese “QE” that will be forthcoming as de-risking/deleveraging gains momentum and China’s Bubble collapse accelerates.

Global bond markets have every reason to take notice. After all, the risk of a deflationary Chinese Bubble collapse has helped underpin bond prices in the face of unending massive supply and mounting inflationary pressures. But suddenly an even greater risk has begun to surface: An increasingly disorderly Bubble collapse could force Beijing into aggressive monetary inflation, even as China and the world are in the throes of an inflationary shock.

September 28 – Bloomberg: “The world’s second-biggest economy is caught in the grips of a widening power crisis that’s threatening to stymie growth and further tangle already snarled global supply chains. At least 20 Chinese provinces and regions making up more than 66% of the country’s gross domestic product have announced some form of power cuts, mostly targeted at heavy industrial users. The reasons are two-fold — record high coal prices are causing power generators to trim output despite soaring demand, while some areas have pro-actively halted electricity flows to meet emissions and energy intensity goals.”

September 30 – Bloomberg (Alfred Cang): “China’s central government officials ordered the country’s top state-owned energy companies — from coal to electricity and oil — to secure supplies for this winter at all costs, according to people familiar… The order came directly from Vice Premier Han Zheng… and was delivered during an emergency meeting earlier this week with officials from Beijing’s state-owned assets regulator and economic planning agency, the people said… Blackouts won’t be tolerated, the people said.”

China’s Producer Price Index was up 9.5% y-o-y in August, the high all the way back to 1995 – when the Chinese economy and Credit system had minimal global impact. The nation’s energy crisis now has the potential to prolong what was expected to be a temporary inflationary spike. China will aggressively compete with Europe and others for stretched global energy supplies heading into the winter heating season. Already pressured by acute worldwide supply chain issues, global inflationary pressures will be bolstered by surging energy and related commodities prices, as well as from rising prices for Chinese goods.

September 24 – Associated Press (Christopher Rugaber): “Restaurant and hotel owners struggling to fill jobs. Supply-chain delays forcing up prices for small businesses. Unemployed Americans unable to find work even with job openings at a record high. Those and other disruptions to the U.S. economy… appear likely to endure, a group of business owners and nonprofit executives told Federal Reserve Chair Jerome Powell… The business challenges, described during a ‘Fed Listens’ virtual roundtable, underscore the ways that the COVID-19 outbreak and its delta variant are continuing to transform the U.S. economy… ‘We are really living in unique times,’ Powell said at the end of the discussion. ‘I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people. … So, it’s a very fast changing economy. It’s going to be quite different from the one (before).’”

It’s beginning to sink in that rising inflation is much more than a transitory phenomenon. Persistent supply shocks and inflationary pressures are altering perceptions, attitudes and behaviors. Would panicked drivers have drained UK gas stations dry before the pandemic? Will businesses large and small manage resources (i.e. materials, inventory and labor) differently after confronting prolonged supply-chain and labor shortage nightmares? Will spiking prices for so many things force governments, businesses and consumers to change purchasing habits? And in the latest indication of altered psychology, plastered across the news was the latest clue on hording behavior: “Costco brings back purchase limits on toilet paper, cleaning supplies and more.”

Powell: “I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people.

Well, never have we seen the Fed print $4.7 TN in two years. Never have we seen such concerted global monetary inflation – from the U.S., China, Europe and the “developing” economies.

From The Institute of International Finance’s Q2 Debt Monitor: “Global debt soared to a new record in Q2 2021. Following a slight decline in Q1 2021, the global debt pile increased by some $4.8 trillion in Q2 2021. At a fresh all-time high of $296 trillion, global debt is now more than $36 trillion above the pre-pandemic level… Mature market debt heading higher again – albeit more slowly… The debt buildup was most substantial in the Euro Area. Largely driven by Germany and France, the USD value of total debt in the Euro Area increased by $1.3 trillion to over $56 trillion in Q2… Total debt across emerging markets rose by some $3.5 trillion in Q2 2021, and now stands at nearly $92 trillion – over $15 trillion higher than pre-pandemic level.”

China’s debt levels rising rapidly: With total sectoral debt up by an estimated $2.3 trillion in Q2 to reach an all-time high of over $44 trillion, the pace of China’s debt buildup has been much steeper than in other countries.

Expanding at a blistering (“Terminal Phase of Bubble Excess”) 23% annualized rate, China ended Q2 with a debt-to-GDP ratio of 329% (led by the Non-Financial Corporate sector’s 158%). The U.S. ended Q2 with a debt-to-GDP ratio of 367%, with global debt at 353%. All-Embracing.

Rather than moderating back toward the Fed’s 2% target, inflationary pressures are broadening and accelerating – energy, commodities, housing and food, most conspicuously. Between last week’s press conference and this week’s congressional testimonies, Chair Powell has been peppered with inflation questions. It has become increasingly difficult to both dismiss inflation risk and assert the Fed has the situation under control. Below are a sampling of his responses:

The current inflation spike is really a consequence of supply constraints meeting very strong demand, and that is all associated with the reopening of the economy — which is a process that will have a beginning, a middle and an end.”

It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse. We see that continuing into next year probably and holding up inflation longer than we had thought.

We have an expectation that high inflation will abate, because we think the factors that are causing it are temporary and tied to the pandemic and the reopening of the economy. These aren’t things that we can control.

We expect that [prices being affected by supply side constrictions] will abate, that they’ll lessen and over time will come back down. Exactly when that will happen is not possible to say, but I would say we should be seeing some relief in coming months and over the course of the first half of next year.

And from the Associated Press (Christopher Rugaber): “Powell has also said that if there were indications that inflation could rise to unsustainable levels, the Fed would hike rates to bring it under control. ‘We just have to balance the two… But I would say our expectation is that inflation will come down and we won’t ultimately face that difficult trade-off of having the two goals in tension.’”

The “two goals in tension” would be stable prices and full employment. Despite an unprecedented 10 million job openings and a 5.2% unemployment rate, Fed officials still assert that the U.S. economy is “far away” from full employment.

September 27 – Reuters (Ann Saphir): “The Federal Reserve’s ‘highest priority’ is to make sure millions of Americans now out of a job can get back to work, Minneapolis Federal Reserve Bank President Neel Kashkari said… ‘Putting Americans back to work…to me that’s our highest priority,’ Kashkari said at the Community Foundations Leading Change Fall Forum, adding that ‘of course’ the Fed will pay close attention to inflation and keep that in check. Recent high readings of inflation do not signal permanently higher inflation, he said: ‘We don’t want to overreact to short-term price movements.’”

I sympathize with the unemployed and underemployed. But at this precarious phase of the cycle, monetary and price stability must be the Fed’s highest priority. Priority must be given to returning stability to a system responsible for the wellbeing of its 330 million citizens. “Money printing” is definitely not in our nation’s best interest, and this runaway experiment in monetary inflation needs to come to an end. Late in the “Terminal Phase” of Bubble wealth redistribution and destruction, our great nation faces greater peril by the day.

Powell: “Of course, if we were to see sustained higher inflation and that were to become a serious concern, I would tell you the FOMC would certainly respond and we would use our tools to ensure that inflation runs at levels that are consistent with our goal.

Higher inflation is in the process of being sustained – and it should today be a serious concern – yet few believe the Fed will actually use their “tools” to suppress it. To begin with, inflation dynamics are not under the Fed’s control. More today than ever before, inflation is a global phenomenon. What’s more, a strong case can be made that China has supplanted the U.S.’s traditional commanding role in global inflationary dynamics.

The eminent market and economic analyst Mohammed El-Erian has been at the top of his game. His Friday Bloomberg piece is spot on: “Demand Is Not the Economy’s Problem. Supply Is – Policy Makers and Central Bankers are Stuck in a Mindset From the Last Crisis and Need to Alter Their Thinking.” And appearing Friday morning on Bloomberg TV, Mr. El-Erian made an astute observation: “When it comes to an orderly taper, the window is closing… We’re still buying $120 billion of assets every single month – what we have been buying since the worst of the Covid crisis. Does it make sense in this environment when demand isn’t a problem, when bond markets are wide open?”

It makes no sense. From my analytical perspective, the window has closed. Bubble fragilities preclude an orderly taper. What’s more, our focus on the Fed is too narrow. The window to a “tapering” of global monetary inflation is at this point likely shut as well. Whether they realize it yet or not, the PBOC has likely commenced what will prove to be massive ongoing liquidity injections. I’m also skeptical that the Fed, ECB, Bank of Japan and the Bank of England will have the gumption to wind down their QE programs.

China is providing an early glimpse of the serious predicament about to envelop the world: liquidity injections necessary to keep Bubbles from imploding will come concurrently with problematic supply shocks, acute economic imbalances, and destabilizing price pressures. At the end of the day, I don’t see the “two goals in tension” being price stability vs. full employment. The unfolding conflict is poised to match general price stability against market stability. If the Fed and others are, here in the ninth inning, determined to sustain securities and asset price Bubbles, the world faces the prospect of momentous Monetary Disorder and inflationary mayhem.

Key Issue: With inflation raging and the Republicans breathing down their necks, will the Fed flinch when faltering markets, in a raving tantrum, demand another quick Trillion or two? So many facets of the current environment point to monumental changes in policy, financial and market backdrops. The halcyon days, where the consequences of egregious monetary inflation primarily manifest in surging securities and asset prices, are drawing to a close.

Could the environment possibly encompass a greater litany of uncertainties? And I would expect markets to become only more volatile and unstable – equities, corporate Credit, commodities, currencies and derivatives more generally. Over the past two weeks, local currency bond yields have surged 121 bps in Turkey, 54 bps in Romania, 42 bps in Chile, 36 bps in Mexico, 27 bps in South Africa and 26 bps in Russia. In the currencies, the Chilean peso is down 2.5%, the Turkey lira 2.5%, the Hungarian forint 2.3%, and the Mexican peso 2.1%.

Pain in “carry trade” leveraged speculation is intensifying, with the U.S. dollar index jumping to one-year highs – likely signaling de-risking/deleveraging dynamics have gained important momentum. EM – including China – sovereign CDS have moved sharply higher. In short, “risk off” contagion has jumped from China’s “periphery” to the global “periphery,” with “core” Chinese and U.S. markets increasingly vulnerable.

Senator Pat Toomey: “We’re now seeing rates of inflation considerably higher than the Fed projected and it’s hurting businesses, consumers, and workers. And you don’t have to just take my word for it. Here’s what the CFO of one of the biggest retailers in America, Costco, said last week, and I quote, ‘Inflationary factors abound. High labor costs, higher freight costs, higher transportation demand, along with container shortages and port delays, increased demand in certain product categories, various shortages of everything from computer chips to oils and chemicals.’ To address this threat, I urge the Fed to accelerate the process of normalizing monetary policy so that it does not fall further behind the curve in responding to the inflation that is already with us.

Original Post 2 October 2021

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