It’s taken nine years and the Bank of Japan supersizing its balance sheet to the $5 trillion mark, but Asia’s second-biggest economy finally has some inflation.
Officials in Tokyo are realizing the hard way, though, that it’s best to be careful what you wish for as bond yields spike.
Granted, the gains in consumer prices Japan is reporting are negligible compared to those in the U.S. and China. And inflation is still a good distance from the BOJ’s 2% target. Still, the 0.5% rise in consumer prices in January year-on-year is already unnerving the bond market. It followed a 0.8% jump in December and marks the fifth straight month of increases.
The worry is that Japan’s inflationis the “bad” kind. Haruhiko Kuroda was hired as BOJ governor in March 2013 to end deflation. Kuroda unleashed tidal waves of liquidity. That drove the yen down 30%, generated record corporate profits and sent Nikkei 225 Average stocks to 31-year highs.
Despite a staggering balance sheet with a -0.10 bps policy rate, Japan has only 0.5% inflation.
And Japan’s yield curve is negative at 3 year tenor and less.
How is it that Japan has virtually no inflation with negative rates but the USA has 7.5% inflation with a 0.25% target rate? Could it be the USA undertook massive fiscal spending related to COVID and reduced energy sources in an effort to go “green” that led to 7.5% inflation??
Between raging inflation and the potential wag-the-dog Russian/Ukraine tensions, The Fed has a lot to consider. Particularly if they are watching the 10Y-2Y Treasury yield curve plunging.
And we have the USD Inflation Swap Zero Coupon rate rising again.
While the Treasury and US Dollar Swaps curve are upward-sloping (not surprising since The Fed has aggressively pushed short-term rates to near zero), we are seeing Treasury Inflation Protected (TIPS) in negative territory until we get to 30 years.
The ICE BofA MOVE volatility index, a yield curve weighted index of the normalized implied volatility on 1-month Treasury options, has more than doubled under Biden.
And with Russian-Ukraine tensions growing, we see WTI crude oil up 96% since Biden took office.
Monday should be an interesting day. The market is now pricing in 6 rate hikes for 2022.
(Bloomberg) What a difference 25 years makes. Worried that inflation was about to turn higher, the Federal Reserve in February 1994 began raising interest rates, taking the federal funds rate from 3% to 6% a year later. As it turned out, those worries were unfounded: The U.S. consumer price index barely budged, finishing the year at 2.7%, right where it had started.
Although inflation in many developed-world countries is now well above those levels — 7% in the U.S. alone — of the major central banks only the Bank of England has started to raise short-term rates. They are now, um, 0.25%. Across the developed world, short rates are still either barely above zero or negative. What’s more astonishing is that even though they have cut their purchases, the Federal Reserve and European Central Bank continue to buy about $140 billion of longer-maturity bonds every month, suppressing long-term yields even as inflation rages.
Some central banks say that rate hikes are coming, but their extraordinary reluctance to deal with actual inflation means it will become entrenched. Not only will policy makers have to raise rates more than they envision, but they will have to cut the size of their massive balance-sheet assets, too. Don’t expect that the process will be anything other than awful for risky assets of all stripes.
Over the last year and a half, inflation has not only accelerated but also broadened. It started with goods prices and has now expanded to services, even in the moribund euro zone. Central bankers and markets still believe inflation rates will come down a lot. The part of the swaps market that in essence predicts inflation in the future is pricing in a drop in the U.S. CPI to 3.6% by the spring of 2023 and to 3.25% the year after. Alas, like central bankers, the inflation swap market’s record is dreadful. In late spring of 2020, markets predicted a CPI of minus 1.35% a year later and staying below zero by the spring of 2022.
The US DollarInflation Swap is a poor predictor of inflation, at least under President Biden.
I’m not suggesting inflation will remain at current nosebleed levels. More likely is that having had a couple of decades of headline inflation that was on the low side — for central bankers, but not for anyone else — we are in for a few years when it remains above their targets.
Short rates will of course need to rise. That is problem enough for markets, but the bigger problem comes from the trillions of dollars of assets that central banks have accumulated on their balance sheets. Taken together, the Fed, ECB, Bank of Japan, Bank of England and Swiss National Bank have some $27 trillion of assets. In 2007, before the global financial crisis, the combined total was a little more than $4 trillion. Central bank assets will stop growing this year, undermining a major source of support for all types of bonds. But if inflation remains persistently high, central banks won’t simply be able to let their assets roll off as they mature, as most assume. They will have to start selling them. That is the big problem.
Central banks resorted to buying bonds and other financial assets (so-called quantitative easing) for a few reasons. The main one was to drive up inflation and inflation expectations from uncomfortably low levels by injecting more liquidity into the financial system and driving down longer-dated yields. Now that central banks have got much more inflation than they wanted, they will, by the equal and opposite token, need to sell the assets they bought. The longer inflation remains at current levels, the greater the pressure to sell. And they will probably need to do so sooner and faster than most expect and at prices a lot lower than they fetch today. The Fed alone owns about 30% of all the notes and bonds issued by the U.S. Treasury Department.
To say that central bank purchases have had a large effect on yields would be an understatement. One way of seeing this is to split the yield of a longer-dated bond into the part that reflects the expected path of interest rates over the life of the security from everything else. That “everything else” is the term premium. This should compensate investors for, say, sudden surges in inflation. Clearly, this is no longer true. Depending on what model you use, the term premium on 10-year Treasury reached a high of 450 basis points to 500 basis points in the early 1980s. At the nadir of the pandemic, it was minus 100 points and is now about minus 10 points. To be clear, this means that you get less buying a 10-year Treasury than would be suggested by the expected path of rates over the life of the bond — expectations that are almost certainly too low.
Term premiums below zero suggest bond investors are no longer compensated for things like inflation.
The driving down of government bond yields also compressed yields and spreads on investment-grade and junk bonds. That was the intent. Junk spreads reached their narrowest level ever in June of last year. With so little yield available in fixed income and central banks seemingly always on hand to bail them out, investors flooded into equities. As a result, many developed-world equity indexes are either very expensive or, in the case of the U.S., not far off their most expensive levels ever based on valuation measures that are a decent guide to future returns. That is what a decade and a half of market manipulation by central banks has done.
The policies of zero or negative rates and seemingly infinite QE looked idiotic (and were) when they were adopted, and time has not been kind. Paradoxically, they could only be sustained if central banks were wrong, and their policies failed to spark inflation. Now that inflation has taken hold, rates will go up substantially and balances sheets will need to shrink.
What would you pay for fixed-income assets now if you knew that central banks will become, in effect, forced sellers later? I can’t see how any financial asset will escape the damage from the likely lurch higher yields. The way out of these policies will be as nasty as the way in was nice.
Particularly since Fed Funds Futures are pointing toward 6 rate increases over the next year.
At least Treasury Secretary Janet Yellen is wearing her Mao jacket.
Raphael Bostic and Goldman Sachs are both calling for dramatic rate increases to fight inflation … that they helped cause with their monetary stimulypto. I call this The Fed’s March of the Toreadors as The Fed now attempts to kill the bull market.
(Bloomberg) — The Treasury yield curve flattened to the lowest level in over a year on Monday as the prospect of a super-sized Federal Reserve rate increase in March gained traction, weighing disproportionately on shorter-dated tenors.
Two-year U.S. yields climbed as much as 4 basis points after Raphael Bostic, the president of the Fed’s Atlanta branch, said the U.S. central bank could raise its benchmark rate by 50 basis points if a more aggressive approach to taming inflation is needed.
That narrowed the gap with ten-year counterparts — which rose about half as much — to the least since October 2020. The last time the Fed delivered a half-point increase to borrowing costs was at the height of the dot-com bubble in 2000.
The repricing extended a move spurred last week, after Fed Chair Jerome Powell underscored the policy maker’s determination to put a lid on inflation. The market positioning may have been exacerbated by hedge funds that had been leaning the wrong way before Powell’s address.
Traders are currently betting the Fed will deliver 32 basis points of tightening in March, more than fully pricing an increase of a quarter-point. That puts the implied probability of a 50-basis-point increase at almost 30%. The odds of such a move in December were zero.
Consumer prices rose an annual 7% in December, the fastest pace in almost four decades. Powell left the door open to increasing rates at every meeting, and didn’t rule out the possibility of a 50-basis-point hike.
In an interview with the Financial Times, Bostic stuck to his call for three quarter-point interest rate increases in 2022, while saying that a more aggressive approach was possible if warranted by the economic data. Bostic is a non-voting member of the FOMC this year.
Since the rapid growth in inflation was caused by a combination of too much Fed stimulus, too much fiscal stimulus and “green” energy policies, it is unclear whether an increase of 50 basis points will do much, particularly if Bostic’s own Atlanta Fed GDPNow forecast of 0.051% is accurate. Raising ratesif the economy is slowing??
To be clear, Bostic and others are trying to signal The Fed’s intent well in advance to avoid a surprise knock-down of the stock market. Or a killing of the bull market.
The misery index is traditionally inflation rate plus U-3 unemployment rate. The RENTER misery index is the Zillow Rent Index YoY + U-3 unemployment rate to demonstrate the hardship of renters because of soaring home prices.
Notice that because of rising home prices, the Renter misery index has overwhelmed the improvement in unemployment.
As I typically do, I will now include The Fed’s balance sheet (as a proxy for Fed stimulus and supporting Federal government expenditures). Yes, you can see that The Fed and Federal government are responsible for our modern day “Grapes of Wrath.”
If we look at the TRADITIONAL misery index, we see that misery remains above 10 (it was below 6 prior to the COVID outbreak in early 2020).
Remember that the REAL average hourly earning growth of Americans is NEGATIVE. Gains in wage growth more than offset by inflation.
I won’t even mention how inflation is crushing retirees since Social Security and pension plans rarely adequately compensate retirees for inflation.
Now for the really bad news. 81-year old senior, House Speaker Nancy Pelosi, has announced that she is running for Congress yet again from leftist-stronghold San Francisco. Although she has an expensive home in Georgetown and a beautiful vineyard in Napa Valley. Pelosi’s vineyard only sells grapes to other wine makers. Not bad for a career civil servant!
I really wanted Pelosi to produce a wine called “The Grapes of Wrath” in honor of her insider trading and massive wasteful spending of taxpayer money that has helped generate inflation, rampant government debt growth and hurting retirees and hourly workers.
Despite inflation growing at 7% (versus The Fed’s target rate of 2%) and U-3 unemployment being only 3.9%, one would have thought that Jay and The Gang would have started increasing rates at the January meeting.
But nooooo. The Fed actually sat on their hands and did nothing.
What did The Fed say?
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent. With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate. The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March. Beginning in February, the Committee will increase its holdings of Treasury securities by at least $20 billion per month and of agency mortgage‑backed securities by at least $10 billion per month.“
According to The Fed Funds Futures data, the market is anticipating 1 rate increase at the March FOMC meeting. And another at the June FOMC meeting.
The Taylor Rule (not used by Jay and The Gang), suggests that The Fed should have their target rate at almost 18%! NOT 0.25%.
The stock market has never started a year falling as quickly as it is now.
The S&P 500 has dropped 11% — heading into correction territory — in the first 16 trading days of 2022 in its worst-ever start to a year, according to Bloomberg data that goes back over nine decades.
The downturn comes as traders brace for the Federal Reserve to tighten monetary policy and a surge in U.S. Treasury yields weighs on the outlook for stocks. A host of technical signals also suggest that more volatility may be coming up ahead.
“The Fed pulled the punchbowl, liquidity has evaporated, and the S&P and NDX broke below their 200dma for the first time since the Covid outbreak,” said Rich Ross, technical strategist at Evercore ISI.
A bear market down to the 3,800 level is likely for the S&P 500, Ross said, given “the dramatic erosion of the technical backdrop, in conjunction with the highest inflation, tightest policy, and most uncertain political and geopolitical condition in years” — not to mention its historic rally since 2020.
The Shiller CAPE ratio is extremely high …. not surprising how much air The Fed pumped into the market tires.
Is this the bubble burst many were expecting once The Federal Reserve starting raising rates?
Well, if today’s market opening is an indication, the answer is yes. The NASDAQ Composite Index is down 1.36% and West Texas Intermediate Crude Oil futures prices are down 2%.
The S&P 500 index is down over 10% since January 3rd.
Drawdown is taking place.
But if you think the US equities are deflating, look at European equities. The Euro Stoxx 50 index is down 4.04%.
COVID and its omicron variant (as well as government reactions such as mask and vaccination mandates) are wreaking havoc on the global economy, but particularly in the USA where the Federal government dumped trillions of dollars in fiscal stimulus along with The Federal Reserve’s monetary stimulus into an economy not prepared for it. The result? INFLATION.
But global supply chains are nearing a turning point that’s set to help determine whether logistics headwinds abate soon or keep restraining the global economy and prop up inflation well into 2022, according to several new barometers of the strains.
Just a week before the start of Lunar New Year, the holiday celebrated in China and across Asia that coincides with a peak shipping season, economists from Wall Street to the U.S. central bank are unveiling a string of models in the hope of detecting the first signs of relief in global commerce.
From Europe to the U.S. and China, production and transportation have stayed bogged down in the early days of 2022 by labor and parts shortages, in part because of the fast-spreading omicron variant.
Among the big unknowns: whether solid demand from consumers and businesses will start to loosen up, allowing economies to finally see some easing in supply bottlenecks. Fresh indicators from the private and official sectors are in high demand because there’s still much uncertainty in industries overlooked by mainstream economics before the pandemic.
Once the realm of trade and industrial organization experts, supply chains “have shifted to center stage as a critical driver of sky-high inflation and a stumbling block to the recovery,” Bloomberg Chief Economist Tom Orlik said. “The profusion of new indices and trackers won’t unblock the arteries of the global economy any quicker. They should give policy makers and investors a better idea of how fast — or slowly — we are getting back to normal.”
The Bloomberg Economics Index
Bloomberg Economics’ latest supply constraint index for the U.S. shows that shortages have trended modestly lower for six months. Even so, strains remain elevated, and the wave of worker absenteeism is adding to the problems at the start of 2022.
Port traffic tracked by Bloomberg shows container congestion continues to rankle the U.S. supply chain from Charleston, South Carolina, to the West Coast. The tally of ships queuing for the neighboring gateways of Los Angeles and Long Beach, California, continued to extend into Mexican waters, totaling 111 vessels late Sunday, nearly double the amount in July.
Source: Bloomberg, IHS Markit, Genscape
Note: Data counts the total number of container ships combined in port and in offshore anchorage area.
Kuehne+Nagel’s Disruption Indicator
Kuehne+Nagel International AG last week launched its Seaexplorer disruptionindicator, which the Swiss logistics company says aims to measure the efficiency of container shipping globally. It shows current disruptions at nine hot spots is hovering near “one of highest levels ever recorded,” with 80% of the problems happening at North American ports.
Flexport’s Guages
Another freight forwarder, San Francisco-based Flexport Inc., last year developed its Post-Covid Indicator to try to pinpoint the shift by American consumers back to purchasing more services and away from pandemic-fueled goods. The latest reading released Jan. 14 “indicates the preference for goods will likely remain elevated during the first quarter of 2022.”
Flexport has a new Logistics Pressure Matrix with a heat map showing demand and logistics trends, and much of those numbers are still flashing yellow or red. Flexport supply chain economist Chris Rogers said in a recent online post that similar grids for Asia and European markets will be part of the research.
The Federal Reserve’s Stress Monitor
Adding their stamp to the burgeoning genre of supply stress indicators were three Ph.D. economists from the Federal Reserve Bank of New York, with the launch its Global Supply Chain Pressure Index. Rolled out earlier this month, it shows that the difficulties, “while still historically high, have peaked and might start to moderate somewhat going forward.” The New York Fed said it plans a follow-up report to quantify the impact of shocks on producer and consumer price inflation.
Morgan Stanley’s Index
Less than a week later came the Morgan Stanley Supply Chain Index. It lined up with the Fed’s view that frictions have probably peaked, though some of improvement ahead will come from a slowdown in the demand for goods.
“Supply disruptions remain a constraint to global trade recovery, but as firms continue to make capacity adjustments to address them, capacity expansion could mitigate these,” Morgan Stanley economists wrote in a report Jan. 12.
Citigroup’s Tool
Citigroup Inc. last week released research that was less optimistic yet complementary to the New York Fed’s work, which Citi said doesn’t factor the role of surging demand as a contributor to the supply disruptions. Sponsored Content The Collaboration Disconnect Atlassian
Co-written by Citi’s global chief economist Nathan Sheets, a former U.S. Treasury undersecretary for international affairs, the bank’s analysis “gives a more complete, and intuitive, picture of the current situation.” While strains may ease in coming months, Citi said, “these supply-chain pressures are likely to be present through the end of 2022 and, probably, into 2023 as well.”
The Keil Institute’s Flows Tracker
In Germany, the Kiel Institute for the World Economy updates twice a month its Trade Indicator, which looks at flows across the U.S., China and Europe. Its latest reading Jan. 20 shows that along the key trading route between Europe and Asia, there are 15% fewer goods moving than there would be under normal times. The last time the gap was that large was in mid-2020, when many economies were reeling from initial lockdowns, Kiel said.
More recently, “the omicron outbreak in China and the Chinese government’s containment attempts through hard lockdowns and plant closures are likely to have a negative impact on Europe in the spring,” says Vincent Stamer, head of the Kiel Trade Indicator, said in a post last week. “This is also supported by the fact that the amount of global goods stuck on container ships recently increased again.”
Baltic Dry Index
The Baltic Dry shipping cost index indicates that costs for shipping materials such as iron ore have decline to where it started under Biden, despite West Texas Crude Oil spot prices begin considerably higher thanks to Biden’s anti-fossil fuel policies.
So as the world comes out of Omicron (and whatever COVID variant rises to take its place), we should see a normalization in the supply chain. And with Intel building a new chip factory in New Albany Ohio (aka, outskirts of Columbus). the supply chain woes will eventually subside.
Then again, there is always the Russia-Ukraine tension that may erupt into a disaster. I suggest that President Biden sent Hunter Biden to Moscow to negotiate on behalf of The Ukraine.
Confounded Interest - Anthony B. Sanders 
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