Nordea with the note:
A crack-up boom, or business as usual?
At the beginning of this year a friend said “he was afraid to hold cash”. Looking at asset price inflation since then it appears he was right to be fearful. House prices have been exploding higher, key equity indices trade at all time highs, metal prices, food prices, lumber prices, shipping costs have all been soaring while central banks are still putting their pedals to the metal (FOMC review). And this despite global sentiment suggesting it’s hiking time…
Chart 1: Central banks putting the pedal to the metal despite sentiment screaming for hikes
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One might even be reminded of the notion of a “crack-up boom” within Austrian economics. In a crack-up boom, a central bank attempts to sustain the boom indefinitely without regard to consequences, such as inflation and asset price bubbles. And, this is key, “monetary authorities continue to expand the supply of money and credit at an accelerating pace and avoid turning off the taps of money supply until it is too late”.
Holding cash in such an enviroment is not rational – better to hold some asset to get inflation protection. We surely hope that central banks won’t “turn off the taps” until it is “too late”, but at least fears that this could become the case have probably played a role in asset inflation over the past year.
Chart 2: Copper prices wildly outpacing Chinese PMI
China is supposed to be the driver of global commodity prices, but then what are copper prices doing up here? China’s Markit PMI has been trending lower since November 2020, and China’s credit impulse has been weakening since October. Perhaps this is evidence of a crack-up boom. One non-Austrian way of understanding a crack-up boom is via understanding the interrelationship of monetary capacity, fiscal capacity and inflation expectations (or fears), for more on that topic click here.
Chart 3: A crack-up boom can be understood as a doom-loop between monetary and fiscal capacity
Keeping things equal, a greater fiscal burden will bring a country closer to “fiscal dominance” which is the point at which a national debt has reached levels so that a nation is unable to pay it down with taxes and instead requires monetary policy support in order to stay solvent. This means that inflation expectations – or at least inflation risk premiums – will rise in the wake of surging debt levels.
Of course, nothing can be kept equal in macro economics, and most consensus economists would probably argue that the US will see potential growth surge under the Biden administration, which will deflate the nominal debt burden – so worrying about inflation according to them simply isn’t “rational”. Perhaps the US is even entering a new version of the “roading 20s”, as some have argued. We’re not sure of the wisdom in hoping for this given what happened in the decades afterwards …
Chart 4: Public debt and budget balances
We are, however, reminded of the situation eg Sweden in the early nineties when we take a gander at the US’s fiscal metrics. Sweden’s currency peg collapsed in 1992, and the country entered a severe crisis as evidenced by a ~11% budget deficit and a gross national debt burden above 60% in 1993. It then took several years of reforms and austerity before the krona and the local bond market fully stabilised. Sure, the US is the global hegemon and the dollar is the main reserve currency, but can we really be sure these numbers are sustainable? And if not, inflation risk premiums should be higher than we are used to.
Chart 5: A SpaceX rocket? No, the price of used vehicles…
On top of the slightly theoretical discussion above, we might also show you a long series of charts showing building price pressures. For instance, the chart above which shows an absurd pick-up in the price of new cars. This alone could perhaps push up core inflation by one percentage point late in the third quarter of this year …
In the fixed income space, we keep our view that yields will continue higher and that curves will keep steepening. The Fed’s average inflation targeting (AIT), 2020s/2021s fiscal and monetary expansion, and a “woke” US administration suggest to us greater inflation risk premiums and thus term premiums than we have seen in decades. We expect the the US 10y yield to gradually climb to the 2.0%-2.1% area.
Chart 6: S&P500 in 2021 vs the seasonal pattern since 1951
However, turning more concrete we would also like to remind our readers that “equities are a winter sport”. At least gauging by seasonal charts this looks true. We are likely heading into more difficult terrain (May to September) for seasonal reasons, while April belongs to one of the best months for the S&P500 historically.
FX mavens might wish to note that May is typically the strongest month of the year for the USD (with the trade-weighted index rising 75% of the time, for an average gain of 1.1%).
We also believe the third quarter could also see more activity from insiders who will increasingly be able to sell shares after the ongoing IPO boom. And macro releases are about to become more interesting as well, especially core inflation and labour market prints.
Statistics Sweden published new LFS unemployment figures over the past week. March unemployment supposedly rose to 9.5% – the highest level since 1998, and indicative of imminent rate cuts by the Riksbank. Thankfully, the number has become completely irrelevant owing to Statistics Sweden’s deficient transition process from the old to the new survey.
Chart 7: Swedish GDP growth vs unemployment changes
Alternative measures of unemployment such as the PES unemployment rate (May 12) instead imply not only that unemployment is back to pre-pandemic levels, that Riksbank ought to lift rates, but also that Swedish growth is about to boom. The Riksbank is, however, stuck in pandemic mode and is much more likely to focus on the imminent plunge in core inflation. Indeed, according to its latest forecast, July 2021 will see the lowest core inflation prints since the summer of 2000. Growth will explode, but the Riksbank will remain on the sideline – if not easing further – for the time being.
What is most important in the week ahead?
In the week ahead, there’s not much news in terms of inflation prints – those will have to wait a week or so, but we’ll get plenty of sentiment data.
Chart 8: NOK/SEK vs the difference in manufacturing sentiment
On Monday we get Scandianvia PMI manufacturing numbers. While our colleagues in Norway will tell us not to pay any attention to the Norwegian number, some clients will do so anyway. And here we note that the Norwegian PMI still looks oddly depressed vs its Swedish counterpart, so some further mean-reversion higher in the NOK/SEK PMI spread should be in order. As long as risk sentiment and oil prices remain strong/up here, buying NOK/SEK on dips makes sense, and a narrowing of the PMI spread might help such long positions.
Chart 9: Swedish production expectations starting to cool somewhat
As for the PMI levels, the EA PMI has recently topped expectations, as did the Swedish NIER survey. So a further improvement in the headline PMIs is likely on the cards. Looking at some details we do, however, see a cooling off in production expectations. Swedish manufacturing production growth is currently indicated to peak this summer (Sweden’s industrial production for March is out on Wednesday 5 May and should show further acceleration).
Chart 10: ISM manufacturing to peak in May according to model
The US ISM manufacturing gauge is due Monday afternoon. It is expected to improve further, to 65.1 in April from 64.7 in March, if the consensus is to be believed. On our models the top won’t be in until in May release, and with this stratospheric sentiment we are not sure any beats or misses will matter much. Market participants may start to focus on various prices paid components, but remember, with energy price base effects the prices paid components were always going to soar – so we need to adjust for that to get a read-through to core inflation.
Chart 11: ISM nominal composite suggests rising core inflation going well into 20222
The nominal ISM composite nonetheless suggests that we’ll get a sustained rise in core inflation going well into 2022 (we will be able to update this chart after US PMI services on Wednesday).
Chart 12: Norges Bank could make the NOK the highest yielding G10 currency this year
Norges Bank will announce its latest rate decision on Thursday 6 May. The only thing we are looking for are comments on the vaccination pace. We think a September hike remains in play, which could – if followed by another hike in December – make the NOK the highest yielding currency in the G10. At the same day, the Bank of England might decide to taper its asset purchase programme – if so the Old Lady would follow in the (QE) footsteps of the Bank of Canada (which is the most hawkishly priced central bank of the G10).
Chart 13: Jobless claims & surveys, suggest strongly accelerating employment growth
US non-farm payrolls is due on Friday and is epxected to rise by 888k from 916k last month. The recent declines in jobless claims – as well as many surveys (NFIB’s job openings at a record high) – suggest that payrolls growth is accelerating. We would thus lean towards positive surprises in coming months.
Chart 14: Payrolls growth of one million implies full employment around Christmas
What is interesting is that if we extrapolate payrolls readings of a million, then the employment-to-population ratio will be back at pre-pandemic levels around Christmas. We are not saying such extrapolations make fundamental sense, but from a market psychological viewpoint – this exercise can’t be construed as anything else than bond-bearish. And even if you think the above exercise is dumb, what if other market participants think it’s not?