How long is transient?
The Bank of England meeting on June 24 concludes this series of major central bank meetings. At its last meeting, Bailey & Co reduced weekly bond purchases. The extension of social restrictions through July provides an additional reason to be cautious, although economic activity is accelerating and consumer prices are rising faster than the medium-term target of 2% for the country. first time in three years.
UK growth is expected to peak this quarter, perhaps just above 4%. He would situate H1 21 growth around 2.6%. The pace of activity should slow down to around 2% in the second half of the year. Growth in H1-22 could be closer to 1.5%. Return to normal, indeed!
Much the same can be said of the United States. The quarterly pace and year-over-year increase is also expected to peak here in Q2-21. The Atlanta Fed and St.Loius’ GDP tracking models see second-quarter GDP at just over 9% annualized rate. The slowdown, however, will be moderated by the launch in mid-July of two new initiatives designed to help lower and middle-class families: the Child Tax Credit (around 36 million eligible families) and the Childrens Credit. earned income tax that will last at least until December. As a result, growth above 3% may be achievable in early 2022, but by H2-22 and the midterm elections, growth is expected to return to the status quo ante below 3%.
June’s preliminary PMI reports are the headline data for the week. They can present a major risk, but in the reaction function of policymakers and private decision-makers, the news will be of little importance, confirming what is already known. Vaccinations allow a gradual and unequal social and economic reopening. Low interest rates, various fiscal stimulus, and the rebuilding of savings appear to provide an environment conducive to robust economic activity. The PMI is a useful snapshot of this process.
Japan is the only G7 country where the composite PMI index is below the expansion / recession level of 50 (48.8 in May). The official state of emergency in Tokyo and several other prefectures is expected to be lifted on June 20, but reports suggest lighter restrictions may be imposed before the start of the Olympics and Paralympics. Holding the games during Covid was woefully unpopular in Japan, although public opinion appears to have eased somewhat. Nonetheless, the G7 statement recognized the importance of holding the event safely “as a symbol of global unity to defeat Covid-19”.
The central banks of Hungary and the Czech Republic are meeting next week. The market is anticipating rate hikes, which have very little to do with the Federal Reserve. Hungary grew 2% qoq in the first quarter. Multilateral organizations (IMF, World Bank and OECD) estimate Hungary’s growth this year between 4.3% and 6.0% and between 4.7% and 5.9% next year. The CPI is up about 5% from a year ago and is approaching 8% on an annualized basis over the past three months. Its key rate stands at 60bp. Raising it to 90bp, which the market expects, is hardly restrictive monetary policy. Next week’s move will likely begin a streak of bulls, with the market anticipating two highs in the second half of the year.
After contracting by 2% in the first quarter, the recovery of the Czech economy is underway. The market (Bloomberg survey) expects growth of 3.5% this year and 4.5% next year. The CPI is hovering around 3%, while the official rate target is a low 25bp. It’s great that the Czech Republic has been able to push its overnight rate well below zero in real terms, but this period is drawing to a close and it has very little to do with decisions made in Washington, DC. The 25bp hike seems discounted, and participants seem convinced of at least one more hike this year, if not two.
The Federal Reserve, the European Central Bank, the Bank of England and the Swiss National Bank have argued that high levels of inflation are temporary. But, of course, not everyone agrees, and some hedge fund managers seem to be talking about their book. One of them claimed that US inflation is closer to 12% than the 5% of the national CPI. Another claimed that if the Fed did not react more forcefully, it would go “all-in” on inflation trade. He defined this as commodities, gold, and crypto.
Central bankers can be mocked and criticized, but they are not the outliers on this issue. The Bank of America’s June survey found that 72% of asset managers view inflation as transient, with 23% saying it is permanent. Nonetheless, the bond allocation fell to its lowest level in three years. Additionally, fund managers consider long-term commodities trading to be the most crowded, eclipsing Bitcoin, which 81% saw in “bubble territory.”
While it has been claimed that crypto, and Bitcoin in particular, is a good hedge against inflation, the proof is not there. For example, the 30-month sliding correlation of the movement of inflation in the United States year-over-year and the price of Bitcoin has been mostly reversed in its brief history. Additionally, it peaked in mid-2017 and in Q1 21 in the 0.35-0.40 area when it peaked.
Gold is not as correlated to US inflation as some might think. Again, running the correlation at the differences between the US CPI and gold on a 30-month moving basis shows a reversal for most of the past seven years. The main exception was from August to September 2018, and even then the correlation was insignificant (less than 0.05). The correlation is now slightly positive (0.015).
To avoid confusion, the fact that gold and Bitcoin have been inversely correlated does not mean that they are significantly correlated to each other. The correlation had been positive (30-month changes) from July 2017 to February 2021. After that, however, it turned negative, and an inverse correlation of around -0.32 is the most extreme it has achieved. The correlation over more granular time frames (daily and weekly) is also reversed.
The CRB index, a basket of commodities, benefits from a better statistical relationship with the US CPI. Before the pandemic hit, however, the correlation (30-month differences) was just under 0.2. The concomitant movement has intensified after the first quarter of 20 and has hovered around 0.40 for the past year, which is the upper bound of the past decade. Remember that the CPI (and the PCE deflator) represent a weighted basket of goods and services. Almost two-thirds of the CPI basket has little to do with the prices of basic commodities: housing (not construction), health care, education, communication and recreation.
Inflation expectations last month appeared to have been boosted by rising oil prices. Since the end of last October, crude oil prices have almost doubled. They are in third place compared to the end of 2019. However, the 10-year breakeven point (the difference between the conventional bond yield and the inflation-protected security) fell from almost 2.6% on May 12 to around 2.3% on June 10. , even as oil prices continued to climb. At the end of 2019, the 10-year equilibrium was slightly below 1.80%. It had not exceeded 2%, the Fed’s target, since the end of 2018.
Some believe that a dramatic rise in oil prices is inflationary. Under Trichet’s leadership, the ECB raised rates in mid-2008, mainly because of fears that the rapid rise in oil could cause prices to rise across the board. On the contrary, a dramatic increase in the price of oil is a negative shock to the economy. In the United States, the oil shocks preceded the end of the expansions. The recovery in crude oil (~ 135%) in July-October 1990 helped to plunge the United States into recession. The price of oil doubled in 1999-2000 and the recession hit in 2001. The price almost doubled between the low in 2007 and early 2008 when the financial crisis hit.
Central bankers like to maximize their tactical flexibility. There’s a good reason Powell and Lagarde hate it, to be more precise. The Fed has not even defined the period of application of its “average” inflation target. Surveys of economists are more precise. The main PCE deflator, targeted by the Fed, despite media insisting on calling the policy rate the Fed’s preferred measure, is expected to return to the 2% target by the middle of next year. Just as the pace of US growth is nearing its peak, the year-over-year inflation rate is also seen by economists as soon peaking. Economists see eurozone inflation peaking in the fourth quarter before falling below 1.5% for most of next year. The UK CPI is expected to peak around 2.3% at the end of this year and early next year, before falling back below 2% by the end of next year.