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Weekly investment update – It’s getting real

Many market observers have been predicting a sharp rise in US real yields for at least a year (ourselves included). In 2021 it never quite came. That was…

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This article was originally published by BNP Paribas Asset Managment Blog ( Investor's Corner)

Many
market observers have been predicting a sharp rise in US real yields for at
least a year (ourselves included). In 2021 it never quite came. That was mostly
because resurgences in Covid infections regularly triggered rallys in US
Treasury bonds. Will 2022 be different?

This time, it may be for real. While we
certainly do not belittle the risk to the economy from future coronavirus
variants, the pattern with Delta and Omicron has been that the economic impact
of each new strain has been progressively less negative.

At the same time, the messaging from the US
Federal Reserve on its monetary policy stance has clearly changed.

Whereas last year, the central bank’s view
was that higher inflation would prove transitory, it has become increasingly
clear that at least some of the price pressures will persist. While Covid may
be fading (slowly) as a macroeconomic factor, the supply chain disruptions will
likely linger.

More importantly, the US labour market appears to be near full employment, meaning that recent wage gains could last for longer. To the degree that the Fed is behind the curve in terms of tackling inflation, we believe the risk now is that the bank raises its policy rate by even more than the market already expects (see Exhibit 1).

US labour market – In better shape than it may look

Many observers viewed the latest US
non-farm payrolls report as disappointing. Only 199 000 jobs were created in
December versus a consensus forecast of 400 000. The disappointment, though,
was more due to overly optimistic expectations than to a surprising slowdown in
job growth.

It is important to recognise the surge in
Covid infections that occurred during the month (and which has worsened since).
Whenever this has happened in the last two years, job growth has slowed
sharply. This has been the case particularly in those industries sensitive to
lockdown restrictions or people’s nervousness when the risk of infection
appeared to be high. As the Omicron wave passes, we expect job growth to
rebound.

Other indicators suggest the labour market
is in fact quite strong. Even though the participation rate edged up in
December (although not among older workers), the unemployment rate fell,
meaning a greater share of those people re-entering the labour force found
jobs.

This offsets some of the pessimism around
the high ‘quits’ rate that reflects the number of people who are voluntarily
leaving their job. This ‘great resignation’ is a positive sign of the dynamism
of the US labour market.

We all appreciate that society and the
economy will in many ways be fundamentally different in the future due to the
pandemic. That means the labour market needs to be reconfigured. So many people
quitting (and presumably taking new, better jobs), suggests this
reconfiguration is happening quickly (and in contrast to Europe, where
stability comes at the cost of economic dynamism).

Market segments benefiting from higher rates

Strong consumer and business demand
combined with lingering supply chain constraints and a smaller labour force are
the factors driving inflation to higher, sustained levels.

At a minimum, US monetary does not need to
be accommodative (as it is today). A return to even a neutral policy rate would
still imply real yields that are perhaps 75-100bp higher than they are today.

The potential impact of such an increase is already evident in the market moves over the course of the real yield sell-off this month. Indices with a positive sensitivity to higher rates such as those for value stocks and commodities have outperformed, while assets at risk from higher rates such as technology stocks have lagged sharply (see Exhibit 2).


Any
views expressed here are those of the author as of the date of publication, are
based on available information, and are subject to change without notice.
Individual portfolio management teams may hold different views and may take
different investment decisions for different clients. This document does not
constitute investment advice.

The
value of investments and the income they generate may go down as well as up and
it is possible that investors will not recover their initial outlay. Past
performance is no guarantee for future returns.

Investing
in emerging markets, or specialised or restricted sectors is likely to be
subject to a higher-than-average volatility due to a high degree of
concentration, greater uncertainty because less information is available, there
is less liquidity or due to greater sensitivity to changes in market conditions
(social, political and economic conditions).
Some emerging markets offer less security than
the majority of international developed markets. For this reason, services for
portfolio transactions, liquidation and conservation on behalf of funds
invested in emerging markets may carry greater risk.

Writen by Daniel Morris. The post Weekly investment update – It’s getting real appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.


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Author: Daniel Morris

Economics

Whither r*?

(Note: This article was delayed because of technical difficulties. I finally found a work around.)Although hand-wringing about Quantitative Easing and the “transitory-ness” of inflation is catching most people’s attentions, there is an interesting theo…

(Note: This article was delayed because of technical difficulties. I finally found a work around.)

Although hand-wringing about Quantitative Easing and the “transitory-ness” of inflation is catching most people’s attentions, there is an interesting theoretical concern that is about to get quite pressing. That is: what is up with r* (which is the modernised version of the “natural rate of interest,” although the word “natural” was finally dropped from the jargon). Although post-Keynesians generally argue that r* does not exist — so this is a non-issue — neoclassicals cannot easily embrace that position.

From what I have seen, various estimation techniques for the not-directly-measurable variables loved by neoclassical theory blew sky high during the pandemic, and I have not paid any attention to whether the techniques have since been patched. My assumption is that this is a major topic of interest for researchers, but I doubt that there will be a consensus fix this quickly.

I wrote about the problems with the Holsten-Laubach-Williams (HLW) estimation technique in this earlier article. The New York Fed website — which previously published the estimate — suspended updates when the pandemic data hit. The chart below what happened to the r* estimate based on the initial data in 2020. I have not updated the chart to include more recent data. As noted in my earlier text, one of the problems with the pandemic data is that it was so extreme that the previous estimates of r* were also mangled, since the fit was much worse than was the case for data ending in 2019.

Even if we do not know what neoclassicals think r* is supposed to be, we can what the real policy rate. Or at least we sort-of can, given that it is unclear what rate of inflation we are supposed to use to get the real rate.

The figure at the top of this article shows what I label as the “historic” real rate: the spot Fed Funds (I use the midpoint of the band) less core CPI. It started off with the same sort of mildly negative values we saw in the past cycle, then went deeply negative in 2021. Since it is hard to see the dates associated with the last plunge, the real policy rate started 2021 at around -1%, then first went below -4% in June (ending at -5.4% in December).

The problem with using the “historic” real rate (although it is common in analysis) is that we are comparing a forward-looking interest rate versus the past year’s percentage change in the CPI. In neoclassical models, the variables of interest are the policy rate, and the next period expected inflation rate.

Expectations Matter. Maybe.

The problem with “expectations” is deciding whose expectations matter. In neoclassical models, we just have a small number of representative households (often one) who are the only entities that matter, so you just need to survey them, since the uncountable infinity of other agents will just agree with whatever representative agent represents them. The problem in the real world is that we never seem to be able to pin down who exactly is the representative agent, and so we have an inconsistent mish-mash of inflation survey results.

The figure above shows the Fed Funds rate deflated by the inflation expectations component of the University of Michigan Survey. On that measure, the real rate started 2021 at -2.9% in January, and dropped below -4% in May, ending the year around -4.8%.

What is the problem that I see? If we look back at the (admittedly mangled by the outlier) HLW r* estimate, it was getting close to 0% at the end of 2019. The real rate based on the Michigan Survey started 2021 about 300 basis points below that, and ended up about 500 basis points lower at year end.

(The HLW algorithm uses a smoothed version of inflation — adaptive expectations! — so the inflation rates would presumably be lower in 2021, at the cost of being higher if and when inflation rates moderate.)

Lots of Stimulus

If we are to believe neoclassical theory, deviations of the real policy rate from r* ought to have a somewhat symmetrical effect on the economy. Unless r* magically moved a lot lower in 2021, there should have been a stimulative effect equivalent to hiking rates hundreds of points above r*.

And that is not all. We had a large fiscal stimulus — which is of course ignored in the HLW algorithm, because everyone knows fiscal policy does not matter — and there is whatever stimulative effect provided by the Fed’s balance sheet expansion.

If one believes neoclassical macro theory, then one should expect inflation to rip even higher in 2022. (Which does put the Fed’s stance into a curious light.) I cannot guarantee that will not happen, so we will need to wait and see. But if it does not, it does raise the question: does r* even exist?

Why Non-Existence Matters

The whole theoretical core of DSGE models are based on the assumption that households trade off future consumption versus the present, and if they do not consume now, they invest in Treasury bills. The ratio of present to future consumption is given by the real interest rate: the Treasury bills have a nominal return, but the future prices of goods should rise by the expected inflation rate.

If the real interest rate does not matter, then that core mechanism of the model is meaningless. Although it was possible to add epicycles to handle things like the financial system, it is harder to replace core dynamics.

Alternatively, we can ask: what is the value of the mathematisation of economic theory, if we cannot answer a basic question like what level of the policy rate is where it starts to slow inflation and/or growth?

Email subscription: Go to https://bondeconomics.substack.com/ 

(c) Brian Romanchuk 2022
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Author: Brian Romanchuk

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Peter Schiff: This Bubble Economy Is Going To Burst

Peter Schiff: This Bubble Economy Is Going To Burst

Via SchiffGold.com,

Peter Schiff recently appeared on the Rob Schmidt Show on Newsmax to…

Peter Schiff: This Bubble Economy Is Going To Burst

Via SchiffGold.com,

Peter Schiff recently appeared on the Rob Schmidt Show on Newsmax to talk about the trajectory of the US economy. Peter explains how the Federal Reserve and the US government created a massive bubble, why it is going to ultimately pop, and how to protect your savings and investments when it does.

The First question Rob asked was how is the Federal Reserve going to fix the inflation problem?

Simply put, it’s not. The Fed will make it worse.

Peter said in the first place, the Fed is lying about the extent of the problem. The CPI doesn’t measure the rise in prices accurately.

If we just use the same CPI that we used during the 70s and 80s, and applied the numbers today, we would get about 15 percent inflation for 2021. So, last year was worse than any year of the 1970s, and it was worse than 1980 when CPI was up 13.5 percent. So, this is the worst inflation we’ve ever seen.”

Peter said, unfortunately, it’s going to get even worse.

We have just seen the tip of an inflationary iceberg.”

How did we get into this mess to begin with?

The Fed created the problem.

They’ve been printing all this money. They sent the printing presses into overdrive during the pandemic. But we had an even bigger problem. The government forced people to stop working during the pandemic. So, people weren’t on the job. They weren’t producing goods. They weren’t supplying services. They should have spent less money because they weren’t earning money. The government made the mistake of sending everybody stimulus money so they could go out and spend money to buy products that didn’t even exist because they weren’t created. That’s why we have a supply shortage — because everybody is spending money that the Fed printed, not money that they earned producing goods and providing services. So, it’s a double-whammy. Prices are going ballistic. And this year is going to be worse than last.”

The Fed has said it plans to raise rates, possibly to 2 percent by 2022. Rob said that doesn’t seem substantial. Peter likened it to spitting in the ocean.

Inflation is already 7 percent, even if you accept the government’s numbers, which are a lie. How do you fight 7 percent inflation with 2 percent interest rates? Remember, the Fed had interest rates at 2.5 percent in 2018 when they had no inflation to fight. CPI was only up 1.9 percent in 2018. Yet, the Fed is not going to raise interest rates now to a level they were back then. So, the whole thing is a lie. The truth is if the Fed actually raised interest rates high enough to fight inflation, it would crush the economy. We’d have a worse financial crisis than 2008. The stock market would crash –bond market, real estate market. Government would have to slash spending because interest rates would skyrocket. And so to prevent that from happening, the Fed is going to not fight inflation and that’s why it’s going to get so much worse.”

But the economy seems healthy. That is until you look beneath the surface. We have record trade deficits. The government is running massive budget deficits.

We’re living in a gigantic bubble, and now we’re beginning to see that because prices are really starting to rise and there’s no way to stop them from going up. And this is when everything comes collapsing down. Because eventually, this stagflationary environment that we’re in, which will be much worse than the 1970s – more inflation and a weaker economy – is going to prick that bubble. So, even if the Fed won’t prick it, the markets are going to prick it for them.”

With inflation so pervasive, Peter said anybody who is retired or who wants to retire needs to get out of dollars.

Inflation is going to wipe you out. It is a gigantic tax and it’s going to impoverish an entire generation unless they act quickly to get into real assets. … You have to own real things that can’t be printed because if you just own paper, you’re going to get wiped out.”

Tyler Durden
Wed, 01/19/2022 – 06:30







Author: Tyler Durden

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Temporary reprieve

Equity markets are recovering some of yesterday’s losses but anxiety and uncertainty continue to dominate after a disappointing start to earnings season….

Equity markets are recovering some of yesterday’s losses but anxiety and uncertainty continue to dominate after a disappointing start to earnings season.

Inflation and interest rate concerns are going nowhere soon and with traders now increasingly considering the possibility of hikes larger than 25 basis points, the possibility of more pain in stock markets is very real.

The idea that we could go from rock bottom rates and enormous bond-buying to rapid tapering, 50 basis point hikes, and earlier balance sheet reduction is quite alarming. We’re talking about markets that have become very accustomed to extensive support from central banks and very gentle unwinding when appropriate. This is quite a shock to the system.

And so far earnings season is not providing investors the comfort they were hoping for. Significant compensation increases and lower trading revenues hurt JP Morgan and Goldman Sachs, and higher wage demands are likely to be a common theme throughout the next few weeks which will put a dampener on the bottom line and not alleviate concerns about persistent and widespread price pressures.

UK inflation jumps again ahead of Bailey appearance

The CPI data from the UK this morning compounded inflation concerns, hitting a 30-year high and once again surpassing expectations in the process. And it’s highly unlikely we’re seeing the peak, with that potentially coming around April when the cap on energy tariffs is lifted considerably to reflect higher wholesale prices. Other aspects will also contribute to higher levels of inflation at the start of the second quarter, at which point we may have a better idea of how fast it will then decline.

Of course, the Bank of England can’t just turn a blind eye until then. The MPC may be willing to overlook transitory inflationary pressures but the rise in CPI has proven to be neither temporary nor tolerable. Instead, it’s become more widespread and the central bank is being forced to act and may do so again next month after raising interest rates for the first time since the pandemic in December. A few more hikes after that are also priced in for this year but if pressures continue to mount, traders may begin to speculate about the possibility of larger hikes, as we’ve seen starting in the US.

All of this should make Andrew Bailey’s appearance before the Treasury Select Committee later today all the more interesting. The central bank has warned of higher inflation and possible interest rate hikes for months but delayed doing so after initial hints ahead of the November meeting. Given what’s happened since, the decision looks all the more strange. Of course, it’s easy to say that with 20/20 hindsight.

Consolidation continues

Bitcoin appears to have gotten lost in the noise of the last few weeks. It’s not falling too hard despite risk assets getting pummelled but it’s not recovering to any great extent either. Instead, it’s floating between support at USD 40,000 and resistance around USD 45,000 and showing no signs of breaking either at this point.

For a look at all of today’s economic events, check out our economic calendar: www.marketpulse.com/economic-events/

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Author: Craig Erlam

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