By Michael Every of Rabobank
US 10-year yields fell further again yesterday, in an even more insistent view that there isn’t going to be any inflation. We are now back to 1.50%, meaning a whole new set of people shouting about how we were going to 2% or 3% or whatever percent just a few months ago now have more-expensive-than-a-few-months-ago egg on their face. That is of course as the May US CPI release today saw a 0.6% m/m gain to pushing headline inflation to 5.0%, a 28-year high, and even core inflation at 3.8% y/y. 1993! Where you, and what were was your inflation experience back then?
I was about to find work in Slovakia, which had just split from Czechoslovakia in a ‘velvet divorce’. No threatened ‘sausage wars’ there, as between the post-Brexit UK and EU: but only because there weren’t any sausages. I recall walking round Bratislava’s crumbling old town center, empty at the weekend as everyone went home to grow food in their countryside plots; finding the restaurants or bars which were open; and playing the game of what was actually on the menu, as opposed to what was listed. (Which, due to the Czechoslovak equivalent of Goskomstat, contained the precise weight in grams of each promised ingredient in the dish.) The wait staff would never tell you: the tradition was that you had to ask line by line, and they would repeat “nemáme” (we don’t have any) until you got to what they did. One paid in Czechoslovak banknotes, which a few months later got Slovak stickers. And inflation was 26% even though demand had collapsed. Given everything was almost literally funny money, and that being 21, all I wanted was beer, fried cheese, and chips, which being made locally were cheap (and good), that didn’t matter to me - just to everyone else growing food at their chata (dacha) over the weekend.
The next year I went to work in Moscow on the promise (slash ‘lie’) of jazz clubs, grilled prawns, and Soviet champagne from a friend who later told me he just wanted me to have the experience. Indeed, the economic crisis was so much worse I was physically shocked. Everything was broken, rusty, or dangerous to touch. A bottle of vodka cost less than a bottle of water. People were drinking themselves to death, and falling past you from above on metro stairs. Long lines of babushky (grandmothers) outside metro stations in the snow held up yesterday’s newspaper, eyeglasses, or a single carrot; and many of them with PhDs in electrical engineering or such like. Shops offered little food, and you had to queue for each counter; calculate the price for XXXg of product X (based to 100g); get a chit; queue at the cashier to exchange the chit and cash for a receipt; and queue again at the first counter to swap the receipt for the goods – if you had calculated correctly. If not, you started again - and so on for each counter. Or one could take a metro ride for an hour into the city centre to buy the cheapest UK supermarket ranges at 4 times their normal price under armed guard.
In short, I know what supply-chain shocks, and “shock therapy”, and systemic inflation, and repressed inflation look like, even if long supressed. The guys who won the Cold War and say this is all “transitory” really don’t. So let’s hope they are right.
As covered yesterday, the drop in US Treasury yields, and extended central bank largesse, makes short-term sense if a further US fiscal boost is less likely due to Washington DC realpolitik, which appears to be the case. And we can perhaps add to that list the 15% G7 minimum corporate tax rate, which Congress will have to sign off on, and yet Republicans don’t seem to like much. And, after getting all the right headlines, the UK wants an opt-out for the City of London (“because markets”); the EU might not be able to agree (for once); and China wants an opt-out too (“because China”). I did say when the news hit last week that this looked purely declaratory. However, as repeatedly underlined here, markets still face other structural shifts that will flow back to inflation longer term: 1) try throwing climate change and then reduced food supply into the mix; 2) and/or the disruption and race for industrial primacy in the Green New Deal/Build Back Better world which all major institutions, and most major governments, say is necessary to mitigate that risk; and 3) the links from both back to national security.
On point one, watch what the weather suggests for crop output this year in key producers. Moreover, striking closer to my stomach at least, Italian tomatoes are potentially about to rot in the fields because of a lack of cans to put them in – and we can expect a lot more of that due to the Bullwhip Effect. Meanwhile, yesterday China --where PPI hit 9% y/y-- said it will ensure key commodity prices are kept stable, starting with coal. Logically, that means either: shortages in China (due to repressed inflation – 我们没有 being the equivalent of nemáme); shortages elsewhere (as China buys everything up, and then subsidises it at home – there was a lot of that kind of “soft budget constraint” thinking going on before 1993 in the Soviet bloc); or a policy that cannot work where global markets get to set prices (as did not apply in the Soviet bloc). Oh, and Beijing is also trying to set maximum property prices for good measure.
On point two, let’s see what the G7 has to say today -- I will cover that key meeting in more detail then -- but anyone who is anyone economically is going to be building their own semiconductors, at the very least. And if we then have too many of them, don’t expect economics to close some fabs back down: demand will have to be created to keep them open, one way or another.
On point three, US President Biden has struck down a Trump-era ban on TikTok and WeChat – which sounds bullish on US-China relations; until one sees the executive order which replaces it, as with much of the Biden administration’s thrust so far, aims at a more durable, comprehensive framework aimed at ongoing risk assessment and action against China. And again, we return to the G7 tomorrow.
1993 was also the year that saw the signing of the Maastricht Treaty in the EU, which has played a key role in the absence of any inflation there. And back in 2021, our ECBeebies expect today’s ECB meeting will see the deposit rate unchanged at -0.50%, the asset purchase plan (APP) steady at EUR 20bn/month, and the PEPP envelope unchanged at EUR 1,850bn. They do expect a “technical adjustment” to the PEPP pace, with a “slightly lower” pace through Q3, but acknowledge the risks are skewed towards a delay of any such slowdown.
But do we really have a clear idea of what is going to happen next on inflation, given so much of it is going to be so political? Nemáme.