I love Bear Traps Report as a contrarian signal. Just do the opposite on commodities:
Complacency is off the charts. Per a BofA survey released Friday,nearly 72% of investors believe inflation is transitory–a decade of conditioning will do the trick every time. This is a startling statistic and the oxygen behind the recent growth-tech sector revival in U.S. equities. Our “Cobra Effect” thesis laid out last Summer 2020 is about 50% played out while the chef is in the kitchen putting the finishing touches on the main course. Next, the plates, candles and table cloth will abruptly be dumped onto the lab of Jay Powelĺs Federal Reserve. The grand-daddy of unintended consequences hasn’t joined us yet. The foundation of transitory inflation in the 2010-2020 period was forged on the back of a powerless labor market. This time around 7.5 million Americans are still being compensated and incentivized NOT to rejoin the labor market. Looking out 12-18months, private sector employers will be forced to continue to pay-up to attract workers back into the labor force. This is a structural, secular change brought on by endless lockdowns that come with long-term side effects. Over 50% of U.S. GDP is in blue states which, powered by MMT (modern monetary theory) central bank debt monetization will use the Covid-19 chip to show extended compassion with the inequality drumbeat growing louder by the week. The unintended consequences of lockdowns have yet to fully appear. The labor force is structurally damaged, evidence is on every street corner in the big GDP states. Our trip back to Manhattan last week was a real eye opener. Five-star hotels once hosting hundreds of employees were being operated with skeleton crews. Coming out of the Lehman crisis in 2010, there were few threats to normalization. This was the fuel behind transitory inflation and what Harvard́s Larry Summers termed “secular stagnation.” Supply chains were as smooth as silk. Re-shoring jobs was a pipe dream, now a Trump torch picked up by team Biden. ESG was in infancy with next to zero buy-in politically. Above all, the labor market was hungry to get back to work, Universal Basic Income was a fantasy dancing in the minds of college professors walking along the banks of the Charles River in Cambridge, Massachusetts. Today, these gems are masquerading around Washington as extended long-term unemployment benefits and are more than difficult to withdraw politically. Investors beware, the roots of sustained inflation are extending below the surface as we speak.
Fed’s Williams: Economic conditions have not progressed enough for the central bank to shift stance: This is a classic trial balloon last week, walk back last week. The Fed took last week to measure the market RISK reaction carefully. They screwed up big time in 2013 so they are clearly in trial balloon mode. We had dinner with Jeremy C. Stein in 2015 and he told us they looked at Bernankés first taper language in May 2013 before the public release like 10x (meticulous reviews), and they thought ahead of time the market could take it!?!? Just 21days later they blew up emerging markets, and then came the BIG walk back. In a post-covid world they DO NOT HAVE this luxury (global economy is too wounded), they MUST trial balloon-measure the result, then quickly walk back… They are trying to protect the $64T of GDP outside the U.S., it is highly deflationary if they blow up the planet́s growth engine. This Week, the Classic Trial Balloon to Walk Back: “More than 8 Fed speakers walked back rate hikes because of a 3% down move in markets. No, I didn’t think they would hike either, but they certainly moved fast to do damage control (walk back). Was it all a dream? 5-year break evens (inflation expectations) began Fed day at 2.49% and drew down to 2.3% the next day… After last week’s Fed Speak they are right back at 2.49%. Meanwhile, the U.S. Dollar (wrecking ball under house arrest), faded lower and is back on the 200-day moving average.”-CIO Summit NJPowell on prices and why they are transitory: “Inflation has increased notably in recent months. This reflects, in part, the very low readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term. As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”-PowellPowell’s dovish commentary shows the Fed will wait for actual inflation as the trigger for any rate increase; they will not raise rates preemptively or in response to very strong employment print. Fueling dollar weakness, we can think of at least ten other central banks around planet earth, far more hawkish (pulling back accommodation more aggressively), than the Federal Reserve.
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The funny part about this analysis is that it is right. But it gets all of the conclusions wrong. The Fed has moved too early on inflation. The reflation trade is in trouble. It may well be forced backward by markets.
But only for a little while because the US is going to lead the new cycle with its excellent fiscal stimulus from later in 2022. Just as Chinese growth fades into deleveraging.
This is NOT commodity price bullish. On the contrary, the Fed will lead global tightening, trailing its robust labour market. EM central banks will be fighting capital outflow with rate hikes not the other way around.
This is spectacularly US dollar bullish. Place that alongside slowing Chinese demand and it is equally spectacularly bearish for commodities.