11 Aug
Finger pointing at US inflation
US threatens to eclipse China's stagflation moon
Pending the CPI data, the New York Fed survey seems to confirm an out-of-control trend.But Beijing’s producer prices (+9.7%) combined with the Covid risk appear to be the real tail risk.
But Beijing’s producer prices (+9.7%) combined with the Covid risk appear to be the real tail risk.
Delta variant aside, all market eyes are on the release of the US inflation figure expected on Wednesday. In fact, a false issue. At least in terms of its direct implications for the Fed’s monetary policy. In fact, Jerome Powell has confirmed in the past that he prefers the employment trend as a reference point for policy adjustments to the price trend. However, the Fed’s call for caution following the publication of the record figures for July seemed to many to be a sign that it was putting its hands on the table with regard to possible downturns in the autumn, precisely because of new contagions and possible restrictions.
It is no coincidence that the time horizon for a systemic reflection on the taper has been postponed until after the publication of the next two readings, in August and September. There is, however, one problem: apart from the fact that the Fed is now operating on the basis of a playbook that is totally disconnected from the fundamentals, a flare-up in prices has immediate consequences for both indices and consumption. And today offered a decidedly alarming spoiler, as the New York Fed’s latest inflation survey can be summed up with these two charts:
if in fact the three-year expectation rose to 3.7% from 3.5% previously, the highest figure since August 2013, it is the divergence within the body of respondents that puts an unprecedented number on the table.
When asked about the 36-month price trend, some 25% of respondents assumed +8.0%, the highest reading since the time series was drawn up. In fact, this is the funeral of the thesis on the transitory nature of inflation. But here are two more graphs:
These open up a paradoxically even more disturbing scenario, prospectively. In both cases, both Deutsche Bank and Piper Sandlers believe that inflation in the US could reach the tipping point at the next forecast, with the August figure showing a gradual downward trajectory.
Above all, the German bank’s comparative data, based on a model linking the 10-year break-even with the skew (a proxy for the risk premium on price increases) drawn up by the University of Michigan, shows how the medium-term figure could undergo a sharp change in sentiment if the August 11 reading were to mark a retreat from that of the previous month and re-enter a regime of downward price compression typical of post-2013. Why disturbing, then? Because of what is represented in this latest chart:
the market-driver obsession that US inflation has now assumed in the debate as a coterie to the broader topic of the taper and its fluctuations, in fact, risks overshadowing the explosion of producer prices in China.
Against a modestly growing CPI (+1.0% year-on-year and +5.3% monthly annualised), the PPI flew to its highest since 2008 as a result of rising commodity prices and increasing tensions on the global supply chain, container costs in the lead. An annualised +9% and an annualised +9.7% on a monthly basis means that the already exorbitant Bloomberg consensus of +8.8% has been exceeded. And here’s the problem: given the Covid outbreaks in China that have already prompted all the investment banks to drastically revise downwards the Dragon’s GDP for the third quarter, what combination is likely to be generated by such a mix? Stagflation.
An apparently lunar concept for an economy like China, which is used to growth rates in the structural 6% area, but one that could definitely complicate the picture, especially for the Fed. In fact, if there is one certainty in the world, it is the one based on the quid pro quo between the two formal enemies, Beijing and Washington: the former guarantees credit impulse to the global system through the continuous injections of the PBoC, while the latter accepts in exchange to import Chinese deflation from super-production. In fact, using it as a pretext for low rates and perennial stimulus. Now, however, the dynamic has changed.
Xi Jinping has long since put the Chinese system on a credit diet, limiting his interventions to cuts in reserve requirements or short-term injections to plug defaults on onshore bonds. On the other hand, a couple of weeks ago the market began to anticipate an expansive return of the PBoC, which had already intervened to calm the tech sector’s falls for fear of contagion to bonds and currency. Moreover, the return of the Covid had reinforced this certainty, as any closures or further slowdowns in growth – already seen in June and July – could have prompted the authorities to embark on an albeit brief round of support.
But with a PPI almost in double digits, what can be done? On the one hand, it could all be solved by a rapid normalisation of the health care situation, which would chase away bad thoughts about the combination of galloping inflation and low growth. But on the other hand, such a sudden stop-and-go could unsettle both the markets and the Fed, which has to deal with the ongoing ping-pong over reflation expectations. The plunge in the price of crude oil, linked precisely to the new contagions in China, speaks volumes in terms of growth expectations. All this, after the Dragon’s oil imports had already slowed dramatically in July from the record highs of June 2020. In short, beware of looking too much at the finger of US inflation. It could eclipse the moon of China’s stagflation risk, potentially a global reset event. At the worst possible time.
