Everyone is worried about inflation, except for the bond market


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Good morning. There are many stories about how the price of turkey will rise this Thanksgiving. This is what I call good inflation: turkey does not taste good, we should all eat less. If you disagree with this or any other equally correct opinion found below, please email us: [email protected] with [email protected].

The bond market and authority

For many market observers, the last US inflation report is the ultimate proof that things are out of control. Former New York Fed President Bill Dudley (Bill Dudley), wrote Bloomberg said on Monday that inflation is getting out of control and the Fed has no good options. If the Fed does not more actively withdraw its quantitative easing policy:

The economy may overheat severely, requiring the Fed to brake urgently, thereby accelerating the recession. In contrast, if the Fed wants to accelerate its asset purchases, “loose the temper“Fed officials have been trying to avoid this situation last year, and it will be inevitable…

most likely, [the dilemma] The Fed will stand by and hope that there will be better news to address inflation, labor market supply, and inflation expectations. But as my old boss Tim Geithner often likes to say, “Hope is not a strategy.”

Former Richmond Federal Reserve Chairman Jeffrey Lacker said on Bloomberg TV on Monday:

The reason why we control inflation, tame it and keep it below 2% is to respond quickly to inflation panics and small problems in the bond market. ..

Three to four percent [policy rates] It won’t surprise me in this cycle.I think [the Fed] We are heading towards major policy mistakes and recovering from them, realizing that they have waited too long, which will result in them having to raise interest rates drastically and try to cool the economy and labor market, which rarely happens and the results are good. .. It is possible that we will reach 3.5%, and we will also push the economy into recession. ..

From Larry Summers Twitter thread From Monday:

The Fed should signal that the main risk is overheating and speeding up the reduction of asset purchases. In view of rising house prices, mortgage-related purchases should be stopped immediately. ..

Excessive inflation and a sense of uncontrollable help to elect Richard Nixon and Ronald Reagan, and may allow Donald Trump to return to power. ..

Although economic overheating is a relatively better problem than a pandemic or financial crisis, unless it is clearly recognized and resolved, it will divert and threaten prosperity and public trust.

Don’t forget, Mohamed El-Erian, also on Monday:

I think the Fed is losing credibility. I think it is very important to re-establish a credible voice on inflation, which has huge institutional, political and social impact. .. I hope the Fed can catch up with local developments.

All these people may be absolutely correct. But the market, especially the bond market, seems to think they are completely wrong.

The federal funds futures market hinted that we might only raise interest rates twice next year, which will not begin until the middle of the year; the bond market hinted that this would be enough to curb inflation more or less. Below is the U.S. Treasury yield curve. The gray ceiling is the increase in yield since mid-September, when interest rates have started to rise recently due to inflation concerns tightening interest rates:

The two and five moved a lot. But 10 took only gentle steps, and 30 shrugged contemptuously. This looks like a picture of inflation, but it will soon subside. The five-year and five-year forward inflation rates have not changed since May and are lower than 2.4%. As Richard Barwell, head of macro research at BNP Paribas, said to me:

[The] The market does expect the central bank to respond now, and the more the market is worried about inflation today, the more we price the front-end interest rate hikes. But the change of belief will also trigger a redistribution of the term premium from back to front-if you think that the central bank will take action today instead of letting yourself fall far behind the curve, then you need less compensation to deal with future major Policy adjustments to curb out-of-control inflation. ..

… [also] The growing pessimism on the global medium-term growth prospects means that if the global hiking cycle becomes a reality, the terminal interest rate will fall.

(By the way, the “terminal interest rate” is not a fee that Bloomberg charges its customers, but the highest policy rate in a given interest rate hike cycle).

Perhaps the most telling thing is that the actual rate of return will only continue to fall:

My naive understanding is that if inflation starts to get out of control, the real rate of return must rise because investors want to compensate for fluctuating future inflation. But this will not happen.

How to resolve the divergence between the market and authority? I can think of four possibilities.

Facts have proved that the market is wrong. What can you say? It happens all the time.

It turned out that the experts were wrong. David Kelly, chief strategist at JP Morgan Chase Asset Management, told me on Monday: “This argument is not popular now, but inflation is temporary.” “In a year’s time, inflation will start with a 2 handle. He cited the huge impact of energy prices on inflation, the reduction in fiscal transfers, and the surge in production. Yes, wages and rents will become tricky, but it means “we are moving towards a world of more than 2%, not the old 2% minus the world”. He even suspects that the first interest rate hike will be in the middle of next year, because inflation and economic growth will fall by then. For Fed officials, “Do you really want to raise interest rates before the midterm elections? What’s the point of bothering the president so much?”

Another (more and more lonely) member of the temporary crew is Matt Klein at Overshoot, who Point out Survey data and actual buying patterns show that American consumers believe that high prices are temporary, and therefore an inflationary spiral is unlikely to occur.

The market is not a good indicatorThe standard version of this view is that Fed bond purchases undermine the information value of the yield curve. Scott DiMaggio, co-head of the fixed income division of AllianceBernstein, pointed out that the curve is also affected by the enthusiastic demand of international investors. Even after currency hedging costs, the yields of government bonds are still higher than those of European government bonds. Or Japanese bonds. Finally, pension funds and insurance companies are desperate to purchase long-term liabilities and long-term assets, which means that regardless of the US economy, 30-year Treasury bonds will become expensive.

The market does not mean what we think it means. Maybe I and many others have misunderstood the bond market. For example, one might argue that the relatively high 5-year interest rate and the relatively low 10-year interest rate are consistent with the hard tightening sometime around next year (this still requires the belief that the federal funds futures market is wrong) . Dudley’s idea seems to be this:

The fact that the five-year and five-year TIPS break-even rates have not risen sharply provides little explanation for the near-term inflation outlook. This means that market participants expect the Fed will eventually complete its work and push the inflation rate back to 2%.

What do you think of Unhedged? It sat on the fence in shame. I have to bet, I would say that even if there is no interest rate hike before then, by the middle of next year, the headline inflation rate will be significantly reduced (for example, around 3 o’clock), affected by the calendar, car prices and energy will no longer rise. . But my confidence in this is not high.

The dual life of taproot and Bitcoin

Bitcoin underwent a protocol upgrade called Taproot over the weekend. The price response is not great; the update has been waiting for some time.

Taproot promises to provide a faster Bitcoin network and better smart contracts (allowing computers to execute the code bits of the protocol), which will help solve the long-standing complaint that Bitcoin is difficult to trade, so it is a bad currency.

Improvements in Bitcoin’s “media of exchange” are welcome, but have raised questions about its “store of value”. Is Bitcoin a payment system or digital gold? Both? What else? (Jack Dorsey thinks it can bring World Peace.)

David Siemer of Wave Financial is a long-time cryptocurrency insider who believes that there is no tension between the story of the medium of exchange and the story of the store of value:

Bitcoin is more like a currency, actually magnifying its store of value.The biggest blow to Bitcoin is always that it is a terrible currency, which means it is very unstable but also very difficult to handle [transact in].

Simer explained that Taproot will help solve the second problem, especially in emerging markets. But is Bitcoin’s volatility still not an obstacle to the practicality of Bitcoin transactions? Do not. “No one complains about upward volatility. Downward volatility is a real problem, but 95% of Bitcoin Stay profitable. “

Well, during the price drop in March 2020, more than half of the circulating bitcoins were at a loss.Upward volatility does hurt currency use cases because no one wants Spend assets that appreciate rapidly.

Of course, if their favorite story-digital gold or digital currency-turns out to be fake, cryptocurrency holders will not be disappointed, as long as one of them is real and the price keeps rising. But in Unhedged’s view, these two disturbing stories may imply very different price outcomes. (Wu Yusen)

A good book

more Research From the “P value should make you doubt” the industry.Also read Robin Wigglesworth’s good book Generalize Debate.

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