Blain’s Morning Porridge April 11 2024: Stickflation will remain chaotic – higher bond yields for longer.
“Can the stability and order of the world be but a temporary dynamic equilibrium achieved in a corner of the universe, a short-lived eddy in a chaotic current?”
Yesterday’s higher than expected US CPI confirms the new reality: inflation is not going back to sleep. It will continue to fester. The global economy will adjust to a new chaotic era; higher bond yields, the return of relative pricing and economic normalisation. Might hurt a bit, but long term better for the economy!
Three-point-five percent is the new 2%? Not as simple as that.
Regular readers might know I am an avid reader of Science Fiction. One of the most interesting things I’ve read in recent years is The Three Body Problem by Chinese writer Liu Cixin. It is now a rather lavish Netflix series, which I rather enjoyed even though it was a bit like condensing War and Peace into a half-hour cartoon. (Not necessarily one to watch with a spouse who isn’t Sci-Fi orientated (she-who-is-Mrs-Blain slept right through Dune 2!), but good nerd-TV.)
I won’t spoil the story, but the crux of any Three Body Problem is there is not a closed-form solution. It’s a dynamic system that remains essentially chaotic.
And thus it is with inflation…..
Inflation is even more complex than a three-body problem of rates, inflation and growth. Rising prices react with other price pressures and have unintended consequences. Prices are not a stable system – whatever central bank economists would like us to believe. When bankers and politicians tell you rates are falling back to 2% – they are guessing, and hoping – which is never a good strategy. Simple as.
Yesterday’s higher than expected US CPI report was yet another wake up and change your coffee supplier moment when it comes to understanding the global economy and markets.
Expectations US inflation would tumble back into long-term lethargy around 2% are proving exceptionally wrong – the new level (the current CPI range in the US) looks to be around 3.5% – requiring a significant shift in market expectations, not the least being real interest rates will remain above 4.5%! Which explains why global bond markets are in such a tizz this morning.. US Treasuries, rather predictably, are back above 4.5% – which seems about right – a 1% real yield! (Bond Yield minus Inflation.)
If bond yields rise, then that has consequences on the relative price of all financial assets – hence the gulp of fear in stock markets y’day. When rates were zero, then speculative equity looked far more “relatively” attractive then than they look today when rates are 4.5%! Go figure what is really cheap or expensive by comparing bond yields with equity risks and returns.
The world has changed. After decades of flat, non-volatile inflation, prices are now in a state of “involuntary spasm” – a constant heightened state of painful price volatility that shows little sign of calming. I’ve called it stickflation, but I’m wondering in Irritable Prices Syndrome might be a better description. I suspect this is long-term – and that’s a good thing.
Economists will dig into the detail of this month’s US CPI data of rising prices across the services sector – everything from accommodation, medical care, insurance and auto servicing and repairs are rising on the back of higher input costs which range from wages, supply chains and the accessibility of spares – and try to connect the dots. They will argue how the trends might stabilise. They might and they might not…
To try to explain: If it costs a consumer more to buy the widget to fix the car to drive to the hospital for a treatment that’s gone up in price because gizmos and sticky plasters are more expensive, and the consumer is already struggling with higher costs across the board, then they are more likely to demand higher wages… The system has moved from stable to unstable.
Then overlay that with global trends – like rising shipping costs because of crisis in the Red Sea (something I’ve been told not to worry about – so I am going to worry more about it), the rising cost of oil to power shipping, or even Russian Ghost-Fleet tankers breaking down because of maintenance and spare part issues, or the long-term implications of China no longer exporting deflation around the globe to the extent it once did.….
Butterflies, flappy wings and hurricanes…
Expectations remain for The Bank of England and the ECB to ease rates in June – but they are likely to suffer the same issue – volatile prices will prove an un-scratchable itch. I suspect the same price unpredictably will impact European central banks decision making before the summer – and put their rate cut expectations back under the microscope. It’s increasingly likely the ECB will cut first to address the weakening European economy.
And therein lies another problem. The US and Europe are diverging. The US is strong, resilient, robust, but Europe is weak, lethargic and anaemic. As US rates remain high, the dollar will strengthen while the Euro weakens… thus increasing resource costs, raising European inflation. Ouch.
And rising consumer prices take on a life of their own. The front page of the FT points out this morning… “Resurgent inflation looms over Joe Biden’s White House bid”. Whatever good Joe Biden has been doing for the US economy (considerable successes, buried deep in piles of Republican denial), the coming US election will be fought on the economy and rising prices as a sign it isn’t working… despite the strength and resilience of US markets, production and consumption!
All the above:
- Persistent sticky inflation
- Higher Bond Yields
- Equity price adjustment
- Political Instability
- Consumer pain (economies can only grow if consumers have discretionary income to consume.)
Will increasingly dominate the agenda through the remainder of this year. Get used to it..
But the really big risk is Policy Mistakes.. that Central Banks will be tempted to ignore the reality of price volatility and inflation, and ease, or be influenced by politics to do the wrong thing…. directed to reinvigorate economic activity with rate cuts, but plunging economies back into the distortion of the QE era. That would be a serious mistake…
Sorry for shorter-than-usual comment this morning, but got to rush…
Bill Blain
Author of the Morning Porridge
Wind Shift Capital
www.windshift.capital
