Yields are rising for the right reasons.
Worries about inflation and bond yields won’t go away. As of this writing, the U.S. 10-year was at a 13-month high, with tricky inflation comparisons just getting started. With this week marking the 1-year anniversary of the global shutdown that sent prices plummeting, even modest moves up in coming months will make for big relative price increases against year-ago negative prints (more below). Then there’s the $1.9 trillion Covid package, bringing fiscal stimulus in a year to an astounding $5.1 trillion, nearly a quarter of U.S. GDP. That’s a lot of issuance for the markets to digest. With the White House set to pivot to an equally costly infrastructure plan, more may be in the pipeline. MMT forever! History tells us global yields and central bank actions tend to be highly correlated. But the Fed, which meets next week, has betrayed no sign of mimicking this week’s exertion of yield control by the ECB, even though the 10-year Treasury yield is up nearly 70 basis points so far this year. The only other times yields rose so violently were in 2016, 2013, 2011, 2008, 2003-04 and 1996—all decent years for stocks (except for 2008). That’s because the increases represented what Renaissance Macro calls “escape velocity,” the point at which the bond market decided the “recovery is happening, things are getting better, but they’re not getting so strong as to act as a counter-cyclical force.” Yields rising for the right reasons. That’s consistent with this year’s equity market, with cyclical value stocks knocking Big Tech off the leaderboard and value outperforming growth by the widest margin in two decades.
This week did see a resurgent tech and growth trade. But breadth was strong across sectors, with the S&P 500 and Dow hitting new highs. Cyclical corners of the market are stretched—energy is running 40% above its 200-day moving average and small-cap valuations have normalized relative to large caps. The next-12-months’ P/E for the Russell 2000 is 1.4 times greater than for the Russell 1000, matching the average over the last 15 years. The big question is whether inflation’s rise will prove transitory as the Fed maintains. As the reopening of the economy speeds up, demand is certain to push up some prices. At virus-affected hotels and airlines, they’ve already rebounded 4.9 percentage points over the last two weeks and are now down 23.6% year-over-year (y/y) versus a bottom of -52% last April. There are other underlying price pressures. Oil has tripled off pandemic lows, copper, lumber and other commodities have soared, and home prices keep setting new highs. On the other hand, healing supply chains should act to push down prices for other bigger ticket goods. Gavekal Research thinks in the end, the countervailing forces between services and goods inflation will wash each other out. TIPS, a good barometer of expectations, have risen only modestly and remain in line with the Fed pinning short rates at zero into 2023. Even if the 10-year bumps up to 2%, it still would be historically low and hardly emblematic of runaway inflation. As the Fed keeps hammering home, the real inflation story begins when the labor market fully heals and the economy remains far from that.
There are good reasons to believe the huge output gap (actual versus potential growth) created by the Covid recession will close this year. Many on Wall Street see real GDP jumping 7% or higher—the most since at least 1984—on unprecedented fiscal and monetary stimulus and massive pent-up demand that’s itching to be unleashed. Consumer sentiment is rising, and households are sitting on an exceptionally large pool of savings, with more checks on the way. U.S. vaccinations are so far ahead of other large nations that one wonders what may happen in June when America effectively has herd immunity and no one else does. Goldman Sachs sees few signs of lasting damage from the crisis—two-thirds of the 25 million jobs initially lost are back, and 38% of the newly unemployed since February 2020 say they’re on temporary layoff. Commercial bankruptcies are down, new business formations are up, and companies and households have embraced new technologies, accelerating productivity-enhancing changes by years. Still, Ned Davis doubts the unemployment gap will close anytime soon. Many people have dropped out of the labor force, particularly women and especially Black women, who already face a 90% wealth gap relative to white men. The Covid crisis clobbered this demographic. Many stayed home to care for children as schools and day-care centers closed. Until labor force participation climbs back not just to its pre-pandemic level but to late 1990s’ peak, it’s difficult seeing higher inflation taking hold … unless the dollar depreciates dramatically. That’s what I’m watching. The dollar.
- Higher mortgage rates aren’t hurting housing Evercore ISI’s proprietary homebuilders survey hit a record high this week, with 88% of respondents describing the spring selling season as “very strong.’’ Also, the Mortgage Bankers Association said purchase applications jumped the most in nearly a year.
- It all comes down to jobs New filings for jobless insurance fell to their lowest level since early November, January job openings rose to an 11-month high and Manpower’s employment outlook survey improved a third straight quarter. The NFIB’s March survey showed small businesses plan to hire back to pre-Covid levels, although that outlook came with some concerns (more below).
- Inflation seems OK so far … Core consumer and producer prices advanced in February in line with expectations, with y/y core CPI at 1.3%, slightly below forecasts, and y/y core PPI at 2.5%, slightly above. Core goods prices in the CPI report posted their steepest 1-month decline since last April, a sign supply-chain issues may be easing.
- … but there are signs it’s building The New York Fed’s consumer inflation expectations survey neared a 7-year high, the ISM gauge of prices paid hit its highest level since 2008 and the NFIB survey found price pressures at their highest since mid-2018. The net number of owners planning to raise prices hit a 13-year high, with several citing wage pressures, in part over struggles to find workers (more below).
- It’s all about workers The NFIB said more than half of March’s respondents struggled to find qualified applicants for job openings—40% said they had positions they were unable to fill, the highest in the history of the series that began in 1975. This is a clear example of structural unemployment, in which workers’ skills set and job openings don’t match. This gap virtually closed prior to the crisis but has risen sharply since.
- One area of housing that’s not so hot Refinancing, which the Mortgage Bankers Association said fell 5% in the latest week and has deteriorated six of the past eight weeks on rising mortgage rates.
A quarter of the economy ‘hidden’ in plain sight That’s the share of annual GDP household production (cooking, cleaning, child care, etc.) would represent if it were paid to a third party (nannies, housecleaners, tutors, etc.) instead of being done by parents—mainly moms. The Bureau of Economic Analysis estimates women on average spend 30 hours per week on household production, versus 20 for men. Indeed, working women did more household production than unemployed men. I’m just saying.
Say it ain’t so, Joe Despite Sen. Manchin’s insistence that the Covid relief package be “bipartisan” and “targeted,’’ the price tag ended up near the initial $1.9 trillion. Renaissance Macro maintains the West Virginia Democrat’s late-stage demands accomplished little more than press opportunities for him to demonstrate his “outsized influence.’’ It thinks the 73-year-old’s unlikely to win re-election in 2024 in his very red state if there’s a Republican presidential candidate atop the ticket, so in the end, he won’t step in the way of progressive priorities that may help Dems. Next up, the filibuster.
Baby bust That’s been a notable pandemic side effect, with births plunging all over the developed world in the year since it hit—13.5% y/y in January in France, the most since 1975. Preliminary data suggest similar trends in the U.K. and U.S. (January births in California and Florida fell a respective 10.5% and 7.2% y/y), and in Spain and Italy, where they already face the challenge of aging populations. Italy's gap between deaths and births was its widest since the 1918 Spanish Flu.