Dear Investors,
Bank of America – Is this only the first of 3 inflationary lag?
“While investors remain guarded and cautious near term for numerous reasons, investors should recognize and position for the coming multiyear boom in U.S.”
Parallels between wwii and coronavirus eras
“Economists and policymakers who focus as much on history as they do on theory have a much better ability to understand the implications of monetary and fiscal policy on both economies and markets.”
“Both eras have been characterized by an interventionist Fed, higher-than-average public deficits, and excessive increases in money supply, which facilitated high nominal GDP growth and eventually very high inflation.”
“The post-WWII era then saw slowing monetary growth leading to disinflation and even deflation, although it took three separate spikes in inflation in a decade before inflation was finally contained.”
“So far, post-pandemic has seen one inflationary spike and one ongoing contraction in money supply, which has also been similarly disinflationary thus far.”
Federal government deficits
“The result of this combined activity was higher-than-typical federal government deficits (financed by central bank balance sheet expansion), money supply growth, nominal GDP growth and – eventually and predictably – inflation.”
“Annual U.S. deficits as a percentage of GDP peaked at more than 26% in 1942,2 while money supply growth peaked at close to 35% in March of 1947.3 Both those statistics have remained the highest levels ever seen by a wide margin; only the post-pandemic era has produced anything remotely similar.”
Money supply has gone negative
“As money supply growth has now gone negative, deficits have normalized, interest rates have risen, central bank balance sheets have stopped expanding and started to contract, and bank lending standards continue to tighten, the strong disinflationary trends should continue in our opinion, and the peak of the inflationary spike should be behind us.”
“However, we would note that in two prior episodes of high inflation—post-WWII and the 1970s—there were three separate and distinct inflationary spikes before inflation was finally subdued.”
BlackRock Institute – The fastest rate hiking cycle since the 1980s is causing financial cracks
“Financial cracks from rate hikes have led to jitters over commercial real estate.”
“The Federal Reserve signaled a pause may follow last week’s rate hike. Yet jobs data showed a tight labor market. We expect a pause but no rate cuts this year.”
The damage
“In the U.S., it’s now evident in the financial cracks emerging from higher interest rates on top of rate-sensitive sectors. Higher mortgage rates have hurt sales of new homes.”
“We also see other warning signs, such as deteriorating CEO confidence, delayed capital spending plans and consumers depleting savings.”
“The ultimate economic damage depends on how far central banks go to get inflation down. The Federal Reserve signaled a pause after hiking rates in May. But it also reiterated that persistent inflation means no rate cuts this year.”
Labor market
“U.S. labor market is still very tight, with a worker shortage persisting. Employment growth has slowed slightly this year but is still increasing at an annualized rate of around 1.7%, not much slower than the historical average.”
“We’ve long said the labor force participation rate will be a key gauge of how labor supply is recovering.”
Unemployment rate
“The unemployment rate fell to 3.4%, the lowest level since before man walked on the moon.”
“And on top of that, wage growth is not slowing. Average hourly earnings increased at an annualized rate of almost 4% in the three months to April and nearly 6% on the month.”
“Employment Cost Index – the Fed’s preferred measure of wage growth – was already close to 5% in Q1.”
RBC Global Asset Management – Do you believe it? 75bp of cumulative Fed cuts by December?
“Fears of an imminent recession contrast with recent corporate earnings and consumer strength.”
“In the US, the labour market remains resilient, and inflation came in below 5% for the first time in two years.”
“In general, we wouldn’t be surprised if volatility picks up in the months ahead.”
“On the data front, the US labour market remains surprisingly resilient, with unemployment falling to 3.4%, a 50-year low, while monthly nonfarm payroll additions continue to run at a healthy clip (200k+).”
Interest rates
“US interest rate markets currently discount approximately 75bp of cumulative Fed cuts by December.”
“This may appear overly optimistic, given the tightness of the labour market and subsequent pass-through into wages and services inflation.”
“In the UK, the BoE hiked rates 25bps to 4.5% as expected, with revisions to the growth forecast ruling out a recession in the near-term. However, with headline inflation still above 10%, real rates are still in deeply negative territory.”
USD dollar
“In FX, the dollar has been stable near the lows of the year. However, the story of the week has been continued compression of volatility in FX, with the relentless hunt for carry unabated.”
“We remain skeptical of this – the forward-looking returns for carry tend to be negative when volatility is this low, most carry currencies screen poorly on valuations and are lacking any risk premium.”
Looking ahead
“On the other hand, recent economic data is displaying strength, and the narrative could easily shift in the direction of the Fed needing to do more on rates to get inflation under control.”
“We therefore have low conviction in the macro backdrop but are biased to expect more volatility and a period of risk-off in markets, as potential risks come to the fore.”
Rothschild & co – china gdp
“China’s GDP expanded 2.2% q/q in Q1-23 following 0.6% in Q4-22, supported mainly by the strong rebound in households’ consumption.”
“Spending on services, particularly traveling, is set to remain strong, although uncertainty remains elevated on other categories as recent indicators have provided conflicting signals about the recovery.”
US business
“US business investment remained weak and almost all the rebound in consumption came almost exclusively from a strong reading in January.”
“Investors remain optimistic regarding the outlook as the S&P Global business confidence index improved once again in April to a 11-month high despite the recent banking stress, suggesting that the Eurozone economic activity gained momentum in early Q2.”
Labour market
“Labour markets remain tight in most countries, in part because demand is robust, but also reflecting a slow post-pandemic recovery in supply, with fewer older workers participating in the labour force.”
“In that context, cost pressures from wages not only remain elevated in most advanced economies, but some measures are showing signs of a re-acceleration.”