Stag(flation) Party

Submitted by Grant’s Almost Daily

Stag party

A whiff of stagflation in the heavy summer air? This morning’s release of the June producer price index showed a 2.3% year-over-year rise in the core (ex-food and energy) reading, topping the 2.1% expected.  That follows a 2.1% year-over-year rise in core CPI yesterday, above the 2% consensus and representing the 16th straight month in which that metric rose by 2% or more.  

Those figures have done little to assuage fears within the Fed of an insufficient inflationary pace (the Fed’s preferred gauge, the core personal consumption expenditures index, rose 1.6% year-over-year in June).  “I am nervous about inflation,” declared Chicago Fed president Charles Evans (meaning not enough of it). Jerome Powell told Congress Wednesday that “there is a risk that weak inflation will be even more persistent than we currently anticipate.”  Recently, both St. Louis Fed president Jim Bullard and Minneapolis Fed president Neel Kashkari advocated for “insurance” rate cuts.

While the monetary mandarins fret over inflation half of the mandate, growth worries loom large. The New York Fed’s recession indicator model rose to 32.9% in June, up from 28% in May and the highest since 2008. That gauge rose above 30% prior to the recessions in 1991, 2000 and 2008 (a glance at the 50-year trend shows few false positives).  Then, too, the yield curve has remained inverted since late May with the three-month yield outpacing that of the 10-year note (itself one of the more reliable recession harbingers), while both the June Chicago Purchasing Managers’ Index and ISM Manufacturing Index’s new-order components fell to their lowest levels since December 2015. As of July 8, the Atlanta Fed’s GDPNow tracker implies that output grew at an annualized 1.4% clip for the second quarter, down from 3.1% in the first quarter.

That evident growth slowdown may be the ace in the hole for bond investors.  In Hoisington Management’s second quarter letter, the stalwart bond bulls reiterate their longstanding (and so far correct) hypothesis that debt saturation will constrain growth and keep yields moving still lower:

With the current global experience of more than two decades of subnormal economic growth in the face of extreme over-indebtedness, numerous cases of sustained historically low levels of real yields have come into focus and the following analysis indicates this recent pattern is likely to persist. If debt levels as percentage of total output continue higher, then investors will likely face even lower future real yields.

But, for Treasury bulls, it’s not just the persistent rise in measured consumer and producer price indices which should be cause for concern. Yesterday’s auction of $16 billion in 30-year bonds priced at 2.66%, more than two basis points above its when-issued level at auction time. Glen Capelo, head of rates at Academy Securities, told Bloomberg that the results were eye-opening: “This is as close to a fail as we’ve seen in at least a decade.” Capelo, who has been trading Treasurys since 1986, observed the unusual backdrop that accompanied the auction: “This is the first time in my lifetime the Fed is actually trying to create inflation.”

One auction does not a trend make, but there are other worrying signs. As noted in the below chart by Bianco Research today, relative bidding interest at two, five, seven and 10-year U.S. Treasury note auctions continues a protracted decline seen throughout this cycle:

At least we’re making it up in volume.

Bond-splainin’

From Bloomberg Opinion today:

With some $13 trillion of bonds worldwide yielding less than zero percent, it would be easy to characterize fixed-income assets as nothing more than a giant bubble waiting to burst. Those who agree probably haven’t heard of the concept of a “Giffen good.”

Goodbye Ph.D. standard, hello B.S. standard?

Bears on vacation

From June 29 at the Omni Hotel Mount Washington, via the Associated Press:

Rather than taking in the historical sights (the resort famously served as the venue for the 1944 Bretton Woods monetary agreement), the furry visitor was merely “in search of a trash can.”