What does a Visual dive into inflation data tell us today?
Gareth Nicholson
Chief Investment Officer (CIO) and Head of Managed Investments for Nomura International Wealth Management
Concerns about inflation have been hotly debated among politicians, economists and investors in recent months, with some arguing price increases are transitory and others worrying about elevated costs in the longer-term, especially with President Joe Biden’s plans for trillions in government spending in the coming decade.
Friday's University of Michigan’s final May consumer sentiment has sparked new debate given respondents expect an inflation rate of 4.6% in the coming year, the highest in a decade.
However, the year-over-year inflation metrics are being distorted by so-called base effects. Because of the very weak inflation prints at the start of the pandemic, annual increases in the price metrics appear larger than they would typically.
Very muddy.
Here are 5 data visuals I found give a few interesting perspectives to the Inflation debate and market implications:
How can you view the recent granule change in CPI relative to each sector and individual history.
I think the CPI Tornado plots refreshed from Ken Liefer post (here) is an interesting way of looking at the data.
The plots show MoM vs QoQ change in CPI plotted on a geom path. Data from Bureau of Labour Statistics and charts in R.
4 takeaways from me:
- The current overall momentum is clearly strong, but not uniform across sectors.
- Driving factors remain Transportation, Recreation, Services and Housing. All which have a decent transitory argument.
- Commodities is also a force, but arguably also facing a transitory argument ( as presented in another chart below)
- Not sure why women apparel is only sector decreasing in price. Maybe be something others can help with clearing up. but as can be seen below this is a long term trend.
Has the long term inflation trends shifted - has there been a regime change?
The chart below ( Len Kiefer refresh from 2019) zooms out to give a perspective of the longer term trend.
5 Takeaways for me:
- No clear signs of a regime shift (yet)
- Medical, Services and Foods & Beverages continue to lead price drive
- Apparel continue to lag
- Transportation and Commodities continue to provide the price volatility
- Recreation is probably likely to be key "trend changer", in my opinion
Drivers of the Recent Commodity Prices acceleration - transitory forces
Bloomberg Economics has used a narrative sign restriction model to decompose the drivers of movements in commodity prices. (more details here). The results suggest that the rise so far this year has been driven substantially by risk appetite, as opposed to fundamental demand or shortages of supply.
I think its an interesting study, which offers food for thought around the strength of the current commodity boom.
Investors have been betting that a strong recovery in the global economy will lift demand sufficiently to justify the new elevated level of commodity prices. Implicitly, they aligned with the inflation hawk thesis that accelerating growth is set to bring price pressure back to consumers sooner than central banks expect.
Absent the anticipated increase in demand at the economy-wide level, there will be a limit to firms’ ability to pass on higher commodity input prices to consumers. As the recent fall from the peak suggests, a rise in commodity prices driven primarily by speculation is also prone to a sudden reversal.
Looking at the model verse commodity prices in past periods. - particularly the recovery from the 2008 financial crisis, the rally in commodity prices was also substantially driven by risk appetite.
Strengthening the argument around the transitory inflation outlook for 2021, given 2008 was also a period when a sharp rise in commodity prices was not matched by substantial increases in consumer prices.
Wage inflation and biggest effects on which Equity Sectors in the short/medium term
Of all the industries hit especially hard by the coronavirus pandemic, Consumer Discretionary group now face an outsized threat from wage inflation. The consumer-discretionary group, which includes retailers, hotels and restaurant chains, employ the most people for every $1 million of revenue- - six times as many workers as S&P 500 energy companies.
What's driving TIPS and the opportunities within Inflation related Bonds
The Fed owns 25% of the Treasury Inflation Protected Securities market, which is nearly 14 percentage points higher than during the previous quantitative easing periods. The Fed is purchasing $6.4 billion of 1-30-year TIPS monthly.
The Federal Reserve's large purchases of TIPS and only incremental increases by the Treasury Department appear to be helping overwhelm the market -- potentially distorting the level of real yields and inflation breakevens.
On top of this, retail investors have looked at goods and commodity-price rises and have purchased TIPS funds as a hedge -- purchasing a net $55 billion since May 2020.
It's impossible to accurately gauge the pricing distortions these demand dynamics are having, yet it could be much more than a few basis points.
Recent inflation prints strengthen the argument for the hedge, but then Treasury Inflation-Protected Securities breakevens and inflation swaps have often done a poor job of predicting the actual path of inflation. For example the market overpriced realized inflation outcomes by more than 50 bps from 2011-14, and in 2015 it underpriced what inflation would ultimately be over the subsequent five years
The challenge for TIPS is determining how distorted the market is due to the lack of effective net supply -- yet what's clear is real-yield volatility has outstripped nominal realized volatility in recent months. This dynamic may change, and we expect it will, as growth improves later in the year and there's more talk of reduced Fed asset purchases.
Even before an actual purchase taper, the Fed may pare its TIPS buying in favor of nominal Treasuries. Such a shift could be followed by a rise in real yields and a decline in inflation breakevens.
Market-derived expectations of price growth are sending a clearer message as the two-year breakeven gauge further outpaced five- and 10-year levels this month -- bucking the norm.
Fixed income investors are clearly leaning to the transitory argument.
What do you think?
Which views do we differ on ?
C-Level Executive, Operating Partner
3 年Gareth, insightful as always and consistent with my much less eloquent description. Commodities have overshot as always and will decrease. From a San Francisco view, I have to wonder about the commercial real estate market. The vacancy rate is almost 20% up from 6% pre-COVID. And today I drove through the financial center at lunch hour and saw maybe two dozen people on the street. The actual office utilization has to be under 20%. I agree recreation could be a wild card as the venues reopen and have to spend additional funds or have less capacity, will they pass on those costs? And finally in the leisure space where have the workers gone and will they return. Or to your point does this mean they have to be enticed back with higher wages. Many people I know in this area have sited this as an issue.
Wealth Manager , Sterling Private Wealth Managers
3 年Great article , some really good insight in here
Founder at Responsible Capital
3 年Thanks for sharing