By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
For markets nervously watching for surges in inflation/wage, and wary of the ECB’s innate (Northern) proclivity for considering paring back more generous of balance sheet stimulus, the bullish turn in US and European bond markets softening yields is amusing, if not odd.
A 3-4bps drop in 10Y UST yields and similar pullback in European yields is arguably not the standard expectations ahead of upside risks from US CPI data and ECB, where improving economic conditions and rising inflation confront exceptional stimulus.
Especially as US JOLTS job report points to an intensifying labour supply crunch (not unlike the NFIB business survey) ordinarily associated with pipeline wage pressures to the upside. But the apparent dissonance between yields and inflation risks/data is resolved once US-China risks are considered.
Biden directing an investigation into whether tariffs on Chinese rare earth magnets are warranted was a harsh reminder that US-China risks are well and alive.
And US-China risks corresponded to a firmer USD in defiance of softer yields. But nothing too dramatic.
EUR was eased off 1.22, AUD slipped back below mid-0.77 and USD/SGD a touch towards mid-1.32.
JPY had some “safe haven” benefit, stifled at mid-109.
US-China risks and distortions cannot be overstated; spilling over to inflation as well.
A Tale of Two Inflations
A tad cliché; but if anything, postulating two sides to inflation understate the complexity of inflation drivers as well as consequences that lie beneath headline print of CPI.
We explore two dimensions to inflation’s duality.
First, the wedge between China consumer and producer inflation serves as a useful reminder that inflation is not a monolithic concept. And so no sweeping conclusions may be derived from any one gauge.
Admittedly, rather than the significant 5.9%-pt gap between CPI (0.9% YoY) and PPI (6.8%) for April, those fretting inflation risks could argue what matters is the acceleration expected for both; with market expectations for CPI/PPI to rise to 1.6%/8.5% in May.
Be that as it may, the wider point is that the two inflation gauges point to very different assessments of inflation risks. Even as PPI is nearing multi-year highs, CPI is not only well below 2-3% policy comfort, but far from breaching thresholds accounting for transitory deviations.
In which case, overreaction to China’s producer inflation is wholly unwarranted. In fact, despite risks of some degree of lagged spillover from PPI, the wider point is that the ability of China’s supply-side to absorb excessive cost-push mitigates inflation risks.
Which brings us to the second aspect of demand-pull inflation risks emerging in the US; and fast becoming a cause for consternation amongst policy-makers and markets alike.
Apart from upstream cost push due to commodity, energy and freight, demand-pull risks are justifiably being sighted in used car price surges as well as brisk pick-up in wages.
Question is, whether and to what degree demand-side inflation proves transitory; as chip production catches up and job market friction eases as fiscal/COVID distortions fades.
The inability to answer this with confidence at this juncture will make for volatility around policy expectations; which suffers added uncertainty of a new “flexible” policy paradigm.
Fed pronouncements of “taper” being resorted to “well before” rate hikes means volatility will be driven by long-end yields (hence term premium) and risk appetite (risk premium). But until clarity emerges on the underlying nature of, and attendant risks associated with, the current spate of inflationary pressures (which are almost certainly exaggerated), it will be difficult to plot the policy course in response.
Markets meanwhile may flourish in the “age of wisdom” as much as they are prone to fumble in “the age of foolishness”.
Credit: Mizuho Bank Ltd