In short, we don't think so.
In the chart above, you're seeing the 10y30y spread and the 10y yield.
The 10s30s is a barometer of the inflation risk premium.
And quite frankly, the market isn't buying that inflation will be sustained.
Yes, the 10y yield is indicating perhaps to many that there is some kind of inflation risk, but from the Macrodesiac view, all that is being exhibited here are base effects.
Take a look at the US 10 year yield (the risk free rate of return) over the last 20 years, and come to a conclusion as to whether we are in an abnormal market or not.
The upper bound is likely capped at 2-2.5% at the max.
This would not inspire the extent of inflation that many are warning about, and the Fed is consistent with this view as well.
An excerpt taken from the Macrodesiac note yesterday...
'Back in late August last year, Powell stepped up to the podium at Jackson Hole (well, it was online), where he outlined a different policy path of Average Inflation Targeting.
Here's where an understanding of that above paper comes into play.
"f inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent.
Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.
To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time.
Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time."
It's all about signalling.
The central bank can't automatically push prices up.
They can only provide behavioural signals to the market to either consume or save.
That is it.
The problem comes when there are broader issues at hand that might make the actual mechanism of achieving policy goals, defunct.
The main one that I have been focusing on of late is of course demographics, and the labour market, which are intertwined.'
Now, let's talk about those demographic issues.
Below is the labour force participation rate for the US.
What I would like to know is how inflation is to be sustained when we have 2% of the available workforce that have taken themselves out of even looking for work on a year on year basis?
You can provide all the stimulus checks you like, but all that is doing is providing a push back to a prior baseline - if fewer people have incomes, there is less consumption, so one of the primary drivers of inflation is dampened.
And with regards to the recent NFP figure of +376,000 new jobs being created in a month, we would have to see that figure be printed month on month until April 2023.
Not so inspiring, is it?
Your eyes may now switch to the savings rate as a critique of what I am suggesting.
The problem here is that this is a ridiculously skewed measure too.
For retirees and the highest income earners, they have captured most of this increase in savings.
But for the poorer income quartiles, they have experienced a broader deterioration in their household savings rate.
When you look at data on consumption broken down by income, you find that the highest marginal propensity to consume segment is the richest households with low liquid savings and high illiquid savings...
But right now, they have both.
The next highest (and is generally consistent through time) is the lowest and middle households.
However, they do not have spare cash to spend!
The pent up demand argument is failing, and I'd argue is more a bubble in financial media and commentators where they are on higher salaries, their family members are too and they (me too) have largely been shielded from the economic fallout of the past year.
Now, I've also got into debates around something a little more concerning too, and that is to do with TIPS (Treasury Inflation-Protected Securities).
You might not have heard of this, but it's effectively a way to protect yourself against the rise of inflation.
I'll take another excerpt from the note written yesterday...
'There's a big problem with this measure.
The Fed has been buying Treasury Inflation-Protected Securities!
The Fed’s buying of TIPS could drive down TIPS yields and drive up the breakeven measure of inflation expectations.
So what we are perhaps seeing here is the market using a key measure of inflation expectations to gauge the macro picture moving forwards, without actually realising that it's distorted.
'But breakevens are high!' is probably the reply that you might get back if you mention a number of factors that contend with the longer term inflation view.
My question then would be to ask whether this would have some effect across the nominal yield curve, causing yields to spike higher and with greater speed, than they should?
This paper might prove key to answering what's going on here.
"Such expectations proxy a situation in which the public does not understand the full structure of the economy and, hence, cannot anticipate the implications of policymakers’ intention to make up for past deviations of inflation from its objective.
By varying the number of economic agents (and, hence, components or blocks) in the FRB/US model who use VAR-based rather than model-consistent expectations, we can adjust the extent to which the public understands policymakers’ commitment to a makeup strategy and the degree to which aggregate economic variables react to news about the future."
The paper concludes with...
Makeup strategies work best when the public understands, believes, and reacts to policymakers’ commitment to offset misses in inflation from the 2 percent objective in the future.'
What we are currently seeing in the market, from my point of view, is merely the Fed signalling that they want to make up for missed inflation goals over the past year and probably before as well.
Now they have the fiscal support, it sounds to them like it might be the right time to do so.
This is most notably seen through Powell's speech at Jackson Hole back in August where he introduced the Fed's new mandate of 'Average Inflation Targeting'.
What I would wonder, specifically to do with TIPS, is whether traders know that the Fed has distorted the TIPS market, since 5y5y inflation swaps have followed it, and have almost gone in lockstep with the Fed's holdings of TIPS.
This would be cause for concern, and if it is understood, alongside the waning macroeconomic indicators, then this would provide a strong basis for the current differentials in rates pricing, and for the inflation narrative to subside.
Welcome normality.
In the chart above, you're seeing the 10y30y spread and the 10y yield.
The 10s30s is a barometer of the inflation risk premium.
And quite frankly, the market isn't buying that inflation will be sustained.
Yes, the 10y yield is indicating perhaps to many that there is some kind of inflation risk, but from the Macrodesiac view, all that is being exhibited here are base effects.
Take a look at the US 10 year yield (the risk free rate of return) over the last 20 years, and come to a conclusion as to whether we are in an abnormal market or not.
The upper bound is likely capped at 2-2.5% at the max.
This would not inspire the extent of inflation that many are warning about, and the Fed is consistent with this view as well.
An excerpt taken from the Macrodesiac note yesterday...
'Back in late August last year, Powell stepped up to the podium at Jackson Hole (well, it was online), where he outlined a different policy path of Average Inflation Targeting.
Here's where an understanding of that above paper comes into play.
"f inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent.
Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.
To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time.
Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time."
It's all about signalling.
The central bank can't automatically push prices up.
They can only provide behavioural signals to the market to either consume or save.
That is it.
The problem comes when there are broader issues at hand that might make the actual mechanism of achieving policy goals, defunct.
The main one that I have been focusing on of late is of course demographics, and the labour market, which are intertwined.'
Now, let's talk about those demographic issues.
Below is the labour force participation rate for the US.
What I would like to know is how inflation is to be sustained when we have 2% of the available workforce that have taken themselves out of even looking for work on a year on year basis?
You can provide all the stimulus checks you like, but all that is doing is providing a push back to a prior baseline - if fewer people have incomes, there is less consumption, so one of the primary drivers of inflation is dampened.
And with regards to the recent NFP figure of +376,000 new jobs being created in a month, we would have to see that figure be printed month on month until April 2023.
Not so inspiring, is it?
Your eyes may now switch to the savings rate as a critique of what I am suggesting.
The problem here is that this is a ridiculously skewed measure too.
For retirees and the highest income earners, they have captured most of this increase in savings.
But for the poorer income quartiles, they have experienced a broader deterioration in their household savings rate.
When you look at data on consumption broken down by income, you find that the highest marginal propensity to consume segment is the richest households with low liquid savings and high illiquid savings...
But right now, they have both.
The next highest (and is generally consistent through time) is the lowest and middle households.
However, they do not have spare cash to spend!
The pent up demand argument is failing, and I'd argue is more a bubble in financial media and commentators where they are on higher salaries, their family members are too and they (me too) have largely been shielded from the economic fallout of the past year.
Now, I've also got into debates around something a little more concerning too, and that is to do with TIPS (Treasury Inflation-Protected Securities).
You might not have heard of this, but it's effectively a way to protect yourself against the rise of inflation.
I'll take another excerpt from the note written yesterday...
'There's a big problem with this measure.
The Fed has been buying Treasury Inflation-Protected Securities!
The Fed’s buying of TIPS could drive down TIPS yields and drive up the breakeven measure of inflation expectations.
So what we are perhaps seeing here is the market using a key measure of inflation expectations to gauge the macro picture moving forwards, without actually realising that it's distorted.
'But breakevens are high!' is probably the reply that you might get back if you mention a number of factors that contend with the longer term inflation view.
My question then would be to ask whether this would have some effect across the nominal yield curve, causing yields to spike higher and with greater speed, than they should?
This paper might prove key to answering what's going on here.
"Such expectations proxy a situation in which the public does not understand the full structure of the economy and, hence, cannot anticipate the implications of policymakers’ intention to make up for past deviations of inflation from its objective.
By varying the number of economic agents (and, hence, components or blocks) in the FRB/US model who use VAR-based rather than model-consistent expectations, we can adjust the extent to which the public understands policymakers’ commitment to a makeup strategy and the degree to which aggregate economic variables react to news about the future."
The paper concludes with...
Makeup strategies work best when the public understands, believes, and reacts to policymakers’ commitment to offset misses in inflation from the 2 percent objective in the future.'
What we are currently seeing in the market, from my point of view, is merely the Fed signalling that they want to make up for missed inflation goals over the past year and probably before as well.
Now they have the fiscal support, it sounds to them like it might be the right time to do so.
This is most notably seen through Powell's speech at Jackson Hole back in August where he introduced the Fed's new mandate of 'Average Inflation Targeting'.
What I would wonder, specifically to do with TIPS, is whether traders know that the Fed has distorted the TIPS market, since 5y5y inflation swaps have followed it, and have almost gone in lockstep with the Fed's holdings of TIPS.
This would be cause for concern, and if it is understood, alongside the waning macroeconomic indicators, then this would provide a strong basis for the current differentials in rates pricing, and for the inflation narrative to subside.
Welcome normality.
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