Updated: Nov 15
"I Want You Back" (Inflation) by The Jackson 5, The Most Popular Song in D.C.?
"I know I gotta make money work. The whole thing is, really, money makes money. That's the whole thing about capitalism. Without the capital, there is no -ism." - Li Lu This week was all about inflation with some traders playing 1970s music as they recall a stretch of stagflation from the late 1960s into the early 1980s. After all, it is of utmost importance to keep dancing while the music is on and anticipate the multitude of outcomes possible. Whether it is the Fed's playbook, surprising deflation kicking back in, or heightened inflation for much longer, we like Jeff Gundlach's perspective of investing being a dishwasher problem -- fit in, reorganize, and replace exposures as time goes on. There are a diverging set of views out there, so it makes sense to review and rationalize them: "Our baseline forecast is that the global economy gradually transitions from a highly unusual pandemic recovery to a more normal expansion starting in 2022. During this transition, demand slows while supply rises, growth shifts from very rapid to merely solid, activity rebalances from goods (and in China housing) to services, and inflation moderates. Monetary policy shifts from highly accommodative to slightly more normal, although the normalization speed varies greatly by economy." - Goldman Sachs Goldman continues their 2022 Macro Outlook: "...we are unlikely to revert fully to the pre-pandemic macroeconomy. New monetary policy frameworks, more ambitious fiscal policy, green investments, and healthier household balance sheets all point to stronger aggregate demand for a longer period." While Goldman is more in line with the consensus at the Fed, Nordea takes a cautious outlook on the recovery and its implications:
"Your lockdowns and travel bans soon limit global and national labour market mobility, which drives inflation."
"By now you have managed to make it look like the equilibrium rate of unemployment (NAIRU) has risen by 2.5-3.0 percentage points..."
"The effects from your actions are forseeable -- you'll get even worse labour scarcity, which drives inflation (and, as a likely bonus, less hospital capacity which could lead to worse health outcomes)."
Moody's Analytics takes a strong stance with the Fed and insists on transitory factors that may have impacted data for longer, but are forecasted to settle in:
"The Fed is in a blind. Its assessment that accelerating inflation is transitory is correct, but it is lasting longer than previously expected. The Fed will remain patient in raising the target range for the Fed Funds Rate, as it knows tightening prematurely will delay the economy's return to full employment."
"The Fed Funds Rate now reaches its equilibrium rate in the first half of 2025 at a touch above 2.5%. Odds are rising that the first rate hike occurs a little sooner. Fed Funds Futures are fully pricing in the first hike to occur next September, but they assign an 80% probability that it occurs in July."
Despite the 1970s dier consequences for risk assets, markets have been looking through a rising Dollar, rising Yields, and Fed Funds indicating as many as 3 rate hikes in 2022. Is market sentiment reflecting a shift from rolling lockdowns to rolling re-openings over time? Do re-openings resolve on of the Fed's primary concerns around bottlenecks whilst spurring economic growth?
Markets are pricing in the first rate hike by the time the taper is expected to conclude in June of 2022 with a greater than 70% likelihood. By December of next year, Fed Funds are showing a greater than 50% probability of three rate hikes.
Those estimates are clearly ahead of the Fed's anticipation, although, they have reiterated their willingness to stay behind the curve for as long as markets permit.
Private Quits Rate as a leading indicator for wage inflation continues to show high turnover rates.
When large structural shifts are in motion, it is natural to see a decoupling from historical norms in many regards. With the humility of assuming we know nothing to begin with, we also need to keep in mind child tax credits, a speedy recovery in the prime-working age population and unprecedented circumstances in a world that's as interconnected as it's ever been.
"I'm probably a broken record on this, but pessimism on labor force participation is *way overdone* and even if this GS disaggregation is right, it doesn't really support that pessimism." - @EconBerger
As was noted one of Nordea's recent reports, the relationship between Job Openings - Unemployment Rate has seen a structural break from last April onwards.
Flexible CPI at the highest levels since the 1980s. As you assess the relative meaning of both sticky and flexible CPI data, it is of utmost importance to look at the relative weighting within each basket and whether this time is indeed different.
Noticeable are two aspects of the most recent uptrend in inflation:
During the late 1960s, sticky inflation was leading flexible CPI
Sharp increases in flexible CPI from 1985 onwards have been followed by some time of plateauing at high levels
Again, in determining how sticky inflation is, we look at the numbers behind the numbers.
Median PCE Inflation | Current Components - Federal Reserve Bank of Cleveland
Ray Dalio's principle of economic cycles alongside George Soros' Reflexivity framework are both solid reference points for what may lie ahead. On the one hand, economic participants take part in a self-fulfilling prophecy where increased lead-times are followed by more orders, leading to increased lead-times.
On the other hand, you have the inevitable mean-reversion of aggregate supply outstripping aggregate demand as CAPEX effects become sensible.
"Only if your behavior is unconventional is your performance likely to be unconventional...and only if your judgements are superior is your performance likely to be above average." - Howard Marks
This Week's Economic Agenda:
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The Role of CAPEX
Whether current climate initiatives are efficient or not, most of the world's advanced economies - and increasingly developing countries, - have made a commitment to net-zero.
There is no doubt that countries will collude and excuse behavior unaligned with agreed-upon terms. Whether it is in line with personal beliefs, as investors, we have to deal with the environment we're provided with and account for variables that will affect the investing process.
It is possible that both sides of the trade can prosper in the current environment. Given that the combustion engine is not projected to peak until 2028 alongside developing economies that will naturally be further behind in the adoption of renewables, energy incumbents may play an essential role in the transition.
Royal Dutch Shell leads in global new-build upstream capital expenditure
Source: Offshore Technology