By Michael Every of Rabobank
Is Inflation 'Gonna Get High?'
US 10-year Treasury yields dipped around 3bp yesterday and, far less relevantly for 99% of us, Bitcoin tumbled nearly that in percentage terms, and gold also dipped – this despite oil spiking, and that despite the US dollar rising.
The trend was related to the headline that talks between President Biden and Republicans over his proposed infrastructure spending bill have collapsed. Recall that on matters of spending in the US, “The President proposes, and Congress disposes”. And that with the Senate 50-50, and Democratic senators Manchin and Sinema opposed to using Budget Reconciliation to ram stimulus through, and to the removal of the Senate filibuster to allow stimulus to proceed on a straight up-down vote, there is no way that this spending can happen - unless something changes. (And if so, what?)
As flagged in the inflation framework we published on Monday, this implies that while inflation pressures will still rise from here near-term because of the ongoing Bullwhip Effect, they will then decline again further out. Indeed, this bullwhip is bearish for the real economy if you caught the surprise drop in German industrial production yesterday, where key auto output fell sharply even as demand spiked: keine semiconductors, nicht war?
In that case, we would again be stuck with the pre-Covid new normal monetary policy shtick: just without the loosey-goosey fiscal policy. We know what economic outcomes that drives - and high inflation isn’t one of them. Imagine the Fed having to keep explaining why it cannot generate higher inflation or lower inequality with low, low rates and high, high QE. The markets just started to that with most of the above price action.
However, there were two other crucial political announcement yesterday in DC too.
First, the Senate passed the US Innovation and Competition Act on a bipartisan 68-32 basis. As covered yesterday, this provides billions for new investments of various forms in various fields, includes funding for scientific research, subsidies for semiconductor fabs and robot makers, and overhauls the National Science Foundation. It also codifies that the iron, steel, manufactured products, and construction materials used in federally funded infrastructure projects --which aren’t perhaps going to happen now?-- must be made in the US. It is, by any measure, one of the most significant industry and science-related bills in decades. And it is aimed squarely at China.
Second, the White House released a 250-page report on its 100-day review of supply chains. The executive summary was long on repetition and short on up-front funding, but made a few things clear. The US is serious about controlling its supply chains to increase resiliency and compete with China. It wants to: develop rare-earths at home; buy components and inputs more from countries it is friendly, rather than antagonistic, with; and to shift production of electric vehicle batteries, cutting-edge semiconductors, and key pharmaceuticals back to the US. The press conference around the release also stated: “First and foremost, American workers. Decades of focusing on labour as a cost to be managed and not an asset to be invested in have weakened our domestic supply chains, undermined wages and union density for workers, and also contributed to companies’ challenges finding skilled talent.”
As also noted in the inflation framework piece from this week, talk --like imports-- is cheap. However, given that the only Republican complaint about this strategy is likely to be that it doesn’t go far enough, we can surely see that we have now passed a political Rubicon. Yes, mistakes will surely be made; things might happen in bursts then pause; and it may be two-steps forward, one step back - but supply chains WILL begin to shift, if only due to national security rather than love of labor. They will either flow back to the US or to allies of the US; and capital flows will shift with them. This will take years, or even decades; but the neoliberal global edifice that peaked before the Global Financial Crisis took decades to build too, and it started, among other things, with President Carter deregulating air-traffic control in 1978 and trucking in 1980.
And here we are today with serious people talking about the potential collapse of the liberal world order from what was the strongest starting position in world history, as financial media keep popping champagne corks at wonderful everything is, and global day-traders flip cryptocurrencies linked to porn stars, while waiting for an irascible billionaire to tweet emojis telling them how to make massive instant returns.
"As we step into the new world, we are no longer sure how much of what we thought we understood about financial and macro-economics is still valid."— zerohedge (@zerohedge) June 8, 2021
Obviously, reversing neoliberalism is going to be inflationary – but it is also going to be a slow burn without fiscal policy to accelerate reticent businesses to act. That’s arguably what matters most going forwards – we have decided to head off for a journey in a new, or rather return, direction. But we haven’t even charged up the (electric) car yet, let alone started out on the road. Once we do get moving, however, expect markets to begin screaming “Are we there yet? Are we there yet? Are we there yet?”
Even the pandemic is related. Yesterday, I noted those advocating Ivermectin (albeit with a Scottish-sounding typo that made it sound like a drug one would get dispensed along with Pebblescillin). On the other hand, in Washington state they are handing out “joints for jabs” to encourage people to get vaccinated, so there is that. As a colleague remarked, soon they won’t have high numbers of new patients, but new numbers of high patients. And this can even link back to monetary and fiscal stimulus, given the combination of extended unemployment benefits and the lack of workers to fill record-highs in opening positions: “I was gonna go to work, but then I got high; I just got a new promotion, but I got high.”
But far more seriously, even Bloomberg now understands that if certain conclusions end up being drawn about virus origins --a decision where politics will play as much of a role as science-- then “brace yourself”. Indicatively, Australian PM Morrison will today give a pre-G7 speech pushing again for a transparent investigation into Covid-19 --which helped trigger the initial breakdown of Aussie-Chinese relations-- while claiming the risk of conflict involving China is rising as the world faces a period of uncertainty not confronted since the 1930s; and he calls on Western allies to work together as they did during the Cold War. (With its bifurcated global economy.)
So, in short, the move lower in key bond yields is right --for now-- because fiscal impetus may be flagging. But those popping champagne corks and thinking ‘New Normal 2.0!’, and “because markets!” might soon need a joint too.