Inflation-Cagematch: Guggenheim Battles Bridgewater Over Bond Moves From Here
The world and their pet rabbit is short bonds right now on growth and inflationary consensus opinions…
Including former bond king Bill Gross, who told Bloomberg TV this morning he was short Treasuries into the recent selloff and remains short 10Y and 30Y Treasury futures since he expects inflation to accelerate to 3-4% soon. Conversely, he also says that “another operation twist may be in our future,” which one should think would be designed to tamp down any tantrums at the longer-end of the curve.
Yields really started cranking after the Georgia elections…
But not everyone agrees, as BofA previously explained, having priced in a dramatic rebound in inflation in coming months on the back of anticipated surges in spending, the market may be disappointed as the “fiscal liquidity trap” proves to have a far stronger gravity than most pundits and politicians expect. It would also mean that inflation – after an initial burst higher in mid-2021 – will collapse, and is why BofA expects that year-end core CPI will be just 1.7% as the upcoming June CPI spike fades. Here are some other reasons why Woodard believes that the market is in for a major disinflationary shock in the second half of 2021.
1. Supply disruptions are temporary. Supply-chain bottlenecks, semiconductor shortages, and manufacturing delays today are likely to be relieved as the labor force returns to work. High prints in manufacturing price indexes (e.g. ISM) largely reflect high commodity prices and therefore headline, not core inflation;
2. Structural job losses. Post-pandemic work-from-home could mean smaller rebounds in restaurants, in-person retail, and business travel. Progress on AI & automation could mean fewer industrial jobs to return to, especially at the low end. Before the pandemic, the Bureau of Labor Statistics projected the number of low-wage jobs to grow >5% over the next decade; now, there may be a net decline of 0.5%, bad news for 13% of low-wage workers still unemployed;
3. Union membership is near record lows, just 11% of the workforce today vs. 26% in 1953. Unions are politically almost homeless, with modern Democrats relying less on union votes and more on big tech donors; within the GOP, even “populist” senators haven’t endorsed the unionization vote at Amazon in Alabama.
4. Capex is coming. In the unlikely event wage growth does accelerate sharply at the low end, companies can accelerate R&D to prevent labor from gaining bargaining power. BofA expects corporate capex to rise 13% in 2021. Note that deflationary tech capex now accounts for nearly 30% of the S&P 500 total, a record high (Exhibit 13);
5. The baby bust. Already-plunging global birth rates accelerated lower: e.g. the Brookings Institution estimates 300,000 fewer babies born in the US this year because of the pandemic. Global central banks have called this one of the single greatest causes of lower GDP growth and falling interest rates.
All of which make sense, but the largest hedge fund in the world disagrees.
Bridgewater‘s Greg Jensen told Bloomberg today that the world is on the verge of a new inflationary wave that could force the Federal Reserve to raise rates earlier than planned
Specifically the CIO notes that Washington’s “extreme” approach to fiscal stimulus looks set to turbocharge consumer prices while threatening the post-crisis bond and stock rally.
“The pricing-in of inflation in markets is actually the beginning of a major secular change, not an overreaction to what’s going on,” Jensen said.
“Economic conditions and inflation will adjust faster than either markets or the Fed are expecting.”
With Breakevens breaking out, he appears to be on to something
Bridgewater has long sounded the alarm over holding bonds amid rising inflation risk, insisting that “cash is trash” and just today that …The economics of investing in bonds (and most financial assets) has become stupid.
Think about it. The purpose of investing is to have money in a storehold of wealth that you can convert into buying power at a later date. When one invests one gives a lump-sum payment for payments in the future. Let’s look at what that deal now looks like. If I give $100 today how many years do I have to wait to get my $100 back and then start collecting the reward on top of what I gave? In US, European, Japanese, and Chinese bonds an investor has to wait roughly 42 years, 450 years, 150 years, and 25 years respectively to get one’s money back and then one gets low or nil nominal returns. However, because you are trying to store buying power you have to take into consideration inflation.
In the US you have to wait over 500 years, and you will never get your buying power back in Europe or Japan. In fact, if you buy bonds in these countries now you will be guaranteed to have a lot less buying power in the future. Rather than get paid less than inflation why not instead buy stuff—any stuff—that will equal inflation or better? We see a lot of investments that we expect to do significantly better than inflation. The charts below show these payback periods for holding cash and bonds in the US, in both nominal and real terms.
As shown, it is the longest ever and obviously a ridiculous amount of time.
After a record loss last year for its Pure Alpha Fund, Jensen is hoping to be right this time, adding that:
“If the risk to equities is higher rates, rates don’t help,” Jensen said.
“The ability to use bonds to diversify has got significantly worse and obviously the ability to use bonds to get returns has got significantly worse.”
Guggenheim‘s Brian Smedley and Matt Bush take the opposite view, that this is not a secular change, forecasting that inflation will generally remain subdued in coming years, allowing the Fed to point to cumulative shortfalls from its two percent goal to support delaying the start of policy tightening.
Market participants have been focused on the prospects for a sharp rise in U.S. inflation amid massive fiscal and monetary easing and a COVID-19 vaccination program that continues to gather pace. Our view is that inflation will generally remain subdued in coming years, allowing the Fed to point to cumulative shortfalls from its two percent goal to support delaying the start of policy tightening.
Incoming data supports our view that underlying inflation is slowing, not accelerating. The release of CPI data for February this week showed that core inflation decelerated to just 0.7 percent on a 3-month annualized basis from 1.0 percent in the three months ending in January. As seen in the chart below, this is one of the lowest prints we’ve seen in the last several decades.
The passage of $1.9 trillion in fiscal stimulus this week certainly bolsters the growth outlook, but we believe that our out-of-consensus view on inflation will be validated once 1) we get through the next few months of noise from base effects in the year-over-year numbers and 2) the lagged effects of the 2020 economic contraction begin to show up in the cyclical components of core inflation.
As the chart below illustrates, the typical post-recession weakness in the most cyclically-sensitive components of core PCE inflation is just beginning. The full impact on core inflation from last year’s sharp decline in activity will take several more quarters to be felt, given the historical tendency for core inflation to lag real GDP growth by 18 months.
In light of our inflation views – and given the recent backup in Treasury yields – we believe that the balance of risks is skewed toward lower bond yields, particularly in the front end and belly of the yield curve.
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So to sum up:
Bill Gross – short bonds, inflation to accelerate, Fed will ‘Twist’
BofA – disinflationary impulse coming in H2
Bridgewater – secular inflation wave is here, higher rates, lower stocks
Guggenheim – balance of risks is skewed toward lower bond yields, particularly in the front end and belly of the yield curve.
And the market is just as divided with growth/value stocks signaling inflation is here while real yields remain more subdued…
And bear in mind that the market is still convinced that any surge in inflation will be short-lived… The five-year Treasury breakeven inflation rate has surged above the comparable 10-year rate since Democrats won the U.S. Senate in January, taking the spread to the most negative levels on record in data stretching back to 2002.
Tomorrow’s big Pow(ell)-Wow may well be the first real ‘tell’ of just what The Fed will stand for.
Tue, 03/16/2021 – 18:25