Pick up your paper carefully this week. It is screaming at you.
- “Inflation is already here” – The Wall Street Journal
- “Inflation Jumps To 13 Year High” – The Wall Street Journal
- “…Fastest rate since 2008” – The Financial Times
- “Inflation, we all know by now, is running hot. Investors shrug off inflation at their own peril.” – Barron’s
- “Little Room for the Fed to Be Wrong on Inflation: Maybe inflation isn’t transitory after all” – WSJ
- “…smoking hot and inevitably getting hotter. It is likely to cause another sharp recession in the US…” – The FT
- “Inflation is back, squeezing families and businesses recovering from the pandemic.… Biden should be worried.” – CNN
- “Even transitory inflation will leave Americans permanently worse off.” – WSJ
- “Inflation leaves global economies sitting on a time bomb. We could be on the brink of excruciating economic pain.” – a Deutsche Bank report, reported by Barron’s
- “The effects could be devastating” – Deutsche Bank
- “Everything Screams Inflation” – WSJ
How can anyone withstand this pandemonium? It issues, after all, not from some Twitter thread, but from the “experts” and the “authorities.” The people who are supposed to know more than you do.
I say: Relax. And so does the market.
The media experts are wrong. This will become clear over the next few months as things settle down.
Still, there is a real danger here. If inflation is caused, at least in part, by an increase in the public’s expectations about inflation (a rather bizarre idea that has become mainstream thinking in monetary policy-making), well then, these headlines are certainly doing their best to push the process along.
The symptoms of the media’s unhingement are everywhere. Some journalists are so taken with this narrative, that their analyses become de-calibrated from the topic and stray into statistical zones that have nothing to do with inflation per se. Others are so determined to make their point, they won’t balk at a little disingenuous exaggeration. One analyst has tortured the data to produce the misleading conclusion that inflation has now reached “a shockingly high annual rate of 8.2%.”
The worst offender in all this, sad to say, is my 2nd favorite newspaper.
Conniptions at The Wall Street Journal
This outcry is the loudest, and the most incoherent, at what is normally the most sober of financial media outlets. The Journal’s editorial page coverage is inflation-phobic to such a degree that they seem to have trouble recognizing what “inflation” actually is, and what it isn’t.
In March, for example, responding to a “surge” in bond yields of about 4 tenths of 1 percent (still well below pre-pandemic levels — and gone the following week), a lead editorial nevertheless concluded that
- “Inflation already is here …
And they cited as their first bit of evidence:
- Bitcoin is up about 80% …”
This is worth a guffaw. Bitcoin? Seriously?
In a subsequent editorial, the Journal went even further into the digital Neverland to make its case, lamenting the rising cost of “non-fungible tokens.” Whatever those actually are…
But we do know what they are not. Bitcoins and NFTs are not part of the market basket tracked by the Bureau of Labor Statistics. In fact, Bitcoin is not a consumer good at all. If it is anything (other than ransom-fare), it is an asset. Like a Treasury bond, or a gold ingot. Assets are never included in the inflation calculation of consumer inflation – for the simple reason that they may appreciate, or depreciate, but they are not consumed. Do we expect to see “inflation” adjusted downward when Elon Musk’s comments cause the next big dip in Bitcoin?
The March editorial continued off-track:
- “emerging-market bonds have been issued in higher-than-normal quantities this year, at abnormally low interest rates; the S&P 500 and Nasdaq set new records this month…”
Again, these are asset classes, not components of the CPI basket. And in any case, normally, one would think that higher stock market values would be applauded. Lower interest rates would be construed as deflationary (cheaper debt service).
None of this has anything to do with inflation. The fact that Tesla stock is up 700% in the last year may have considerable significance, but it does not signify consumer inflation.
By June, the Journal’s reality distortion had amped up. Following the release of the May Consumer Price Index figures, they wrote:
- “The Labor Department’s consumer price index surged 5% year-over-year in May, the largest increase since when oil was $140 a barrel. … Let us pray [!?]”
This $140/barrel reference is not even a red flag. It is a red herring. The price of oil is back where it was before the pandemic, and nobody thinks it’s going to $140.
The Journal has more bad news:
- “Over the last 12 months, inflation is up 3.8% and much more for used cars (29.7%), airline fares (24.1%), jewelry (14.7%), bikes (10.1%) …”
These are product categories that show very specific pandemic-related distortions, which do not reflect not sustained price trends. (They should know this.)
And still more:
- “Commodity prices for lumber have surged. Higher lumber prices are adding $36,000 to the price of a new home.”
This is not consumer inflation. Consumers don’t buy commodities. They buy manufactured products. They buy a house, not a pile of 2×4’s.
And in any case, why even cite the price of lumber? This is certainly another bottleneck effect. It is already resolving itself the way bottlenecks always do. The WSJ’s headline June 15 – just five days after the scare-piece cited above — reads: “Lumber Prices Are Falling Fast…”
(Lumber has been a hot topic in the inflation narrative. We’ll look more closely at lumber prices and the housing costs in an upcoming column.)
The Journal’s final complaint makes no sense at all as an inflation indicator:
- “Record low mortgage interest rates have enabled homeowners to lower their monthly payments to burn more cash on other things.”
Obviously, a reduction in mortgage costs is not inflationary, and the fact that this leaves more cash in consumers’ pockets “to burn” on other things is hardly a bad outcome.
The alarmism gets worse.
The Journal’s feature story following the May CPI release raised the possibility that inflation may even lead to civil disorder.
The full-page headline read: “When Americans Took to the Streets Over Inflation: In the 1960s and 1970s, spiraling prices wreaked havoc on the U.S. economy… a warning for today”
- “The protests were against rising grocery prices… a “housewife revolt.” Fed up with the increasing cost of living, they marched outside of supermarkets with placards demanding lower prices. The picketing started in Denver and swept to other cities, prompting Time magazine to report that boycotts were spreading ‘like butter on a sizzling griddle.’”
This is surely not an innocuous allusion, given the social turmoil America has experienced in the past year. (Somewhere in all this there are boundaries labeled “responsible journalism.”)
But is this an accurate picture of the current state of the economy?
Does Any Of This Make Sense?
The short answer is No.
The headline numbers are distorted. They overstate the true inflation rate significantly. “Real” inflation – the sustained trend in actual prices – is probably half the raw CPI. (See my previous columns for the details.)
More importantly, the markets aren’t listening to all this negative skew.
The Market Response
The impact of real inflation — and of the fear of inflation – on the financial markets is said to be negative in three ways:
- increased volatility
- sharp declines in bond prices, and potentially the value of the dollar
- general weakening of equity valuations
The panic narrative calls for the markets to go haywire. The WSJ headline on June 2 told us so: “Investors Worry Inflation Will Bring Wild Market Swings.”
- “Investors are preparing for a more volatile world… Financial markets will be upended by inflation… [In fact] higher inflation is already making markets more volatile, making things worse…”
Already more volatile?
Actually – no.
Following the May CPI release, the equity markets were the calmest they had been in 16 months.
The same is true for bond market volatility.
What about bond prices? Inflation is supposedly toxic for fixed income.
- “Higher inflation should be bad for bonds, which already yield far less than the inflation rate.”– Barron’s
The prospect of serious inflation should crush the bond market, and this would show up as a surge in bond yields as investors dump bonds and force down prices. This has not happened.
In the last month, bond prices have surged. The yield on the 10-year Treasury absorbed the May CPI report with apparent equanimity – and fell like a stone. The decline last week –- the very week when the May CPI was released – was the largest in quite some time. In fact “US Treasuries had the best week in a year.”
This has much of the commentariat stumped.
- “Why would a rational investor buy bonds that yield under the rate of inflation?” – Barron’s
(Perhaps because there is no inflation?)
In any case, the bond market behavior does not align with the inflation-scare narrative, and until recently this inconvenient news has been buried in the back pages. Even there it has been presented as an anomaly in the context of “inflation” as a fact.
- “Treasurys Rally Despite Bubbling Inflation” –– (WSJ, p. B1)
- “Inflation Bets Run Out of Steam As Bonds Rally” – (FT, p. 10)
Some analysts try to explain it away by ascribing falling bond yields to the effect of a cheaper dollar
- “Cheap Dollars Attract Foreign Investors to Treasurys… The low hedging cost [of the dollar] makes the U.S Treasury attractive relative to others.”
This argument does not hold up. First of all, the dollar is not cheaper lately. It is up (a bit) since the beginning of the year, and up in the recent weeks despite the inflation talk.
Last week, the top-performing asset classes tracked by the Wall Street Journal were US Treasurys (the 20-year, #1) and the US Dollar (#2) – both of which should have suffered under true inflationary trends.
German and Japanese bond yields also fell over the last month.
The 10-year bond yields of the UK, The Netherlands, Sweden, Italy, Spain, Australia, France, all declined by similar amounts. Bonds prices all over the world are rising in value, despite the media’s inflation“threat.”
The Much-Feared “Breakeven”
Inflationistas love to cite a particular metric known as the 5-year Breakeven Inflation Rate. This is defined as the difference between the yield on the 5-year Treasury Bond and the yield on the Inflation-Indexed version of the 5-Year treasury Bond. For example, on Thursday June 10 (the day of the May CPI Release), the yield on the 5-Year Treasury was 0.74% and the yield on the 5-Year Inflation-Indexed Treasury was negative 1.74%. The difference is 2.47% – which is taken to be an expression of investors’ expectation of the average inflation rate in the next five years. As shown here, this metric has also declined significantly over the last month, and especially over the last week – despite the inflation warnings.
There are other, rather technical indicators that some analysts follow. For example, the so-called 5 Year/5Year Inflation forecast — a Federal Reserve measure of the expected inflation over a 5-year period starting 5-years from today (so, the projected inflation rate is for June 2026-June 2031), as derived from current yields on the relevant Treasury instruments. That measure also fell dramatically last week.
An even more exotic metric, similar in spirit, called the 5-Year/5-Year Overnight Indexed Swap also fell on Friday to its lowest level since February.
We could go on (there are other market metrics that can be parsed for signs of inflation) – but what’s the point? It seems that no matter how you take the bond market’s temperature, the inflation fever has abated.
In summary, market expectations of future inflation have dropped, not risen, despite the April and May CPI reports. There is no evidence from the bond market at this moment of an increasing expectation or fear of sustained inflation in response to the CPI figures.
What about the stock market?
Again, the headlines have been dire. Following the release of the April CPI, the market dipped briefly…
- “Inflation Surge Rattles Markets: Stocks Log Worst Streak in Months” – (WSJ May 13)
However, following this scare headline, the market resumed its climb over the next month to an all-time record on the day after the May Consumer Price Index figure was released. The market rose further the following week, before sagging after Fed Chairman Powell’s press conference on June 17, and St Louis Fed President Bullard’s comments on June 18.
As with all market movements, there are a variety of possible interpretations. Mine is that the inflation figures in April and May obviously did not cause the stock market to pull back. The market is not showing sensitivity to the inflation scare in the media. The drop following the Fed FOMC meeting is not untypical – the market has become extraordinarily sensitive to such pronouncements – and probably will correct as the market absorbs the Fed’s slightly adjusted policy views. We’ll see.
The Market’s Overall Assessment
Low volatility, record prices – calm seas, prosperous voyage.
Of course, the market weather could change at any time. Volatility was up a bit last week. But for the media screamers, the past month’s performance is an embarrassment. Some pundits were nonplussed.
- “It is bizarre that investors are growing more comfortable as inflation keeps coming in higher than they expected.”
Bizarre. Others call it “strange” – “befuddled” – “counterintuitive” – “an extremely strange set of conditions.” Perhaps it is “investor complacency.” Or frightening negligence on the part of the Federal Reserve – “It often feels as if no one is in charge of monetary policy in the world’s largest economy.” In any case, for many of these commentators, “the market reaction is unnerving, and extreme.”
This so-called “extreme” reaction is actually… no reaction. The markets are acting like this is business as usual, and probably it is. It is only “bizarre” or “extreme” for those who buy into the hyperventilated inflation narrative. If, on the other hand, there is no real, sustained inflation in the system, then market’s behavior appears moderate, sensible, even…shrewd (on the well-established principle that headline sentiment is generally a contrary indicator, pointing left when the market is going right, etc.).
The markets are voting for normalcy here, for recovery and prosperity. This is also the scenario endorsed by the Fed, and by many (most) economists: a strong recovery, with some stress-points and bottlenecks, but not a lurch back to the sustained inflation of the 1970s .