In my daily data life, I check out movements in commodity prices just to see what is going on. As I wrote recently in my UK Guardian article (June 7, 2021) – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman – the inflation hysteria has really set in. I provided more detail in this blog post – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman (June 9, 2021). Yes, I stole the title of my article for the blog post if you are confused. The inflation hysteria really reflects the fact that mainstream economists are ‘lost at sea’ at present given the dissonance between the real world data and the errant predictions from their economic framework. They cannot really understand what is happening so when they see a graph rising it must be inflation and that soothes them because rising deficits and central bank bond purchases have to be inflationary according to their perverted theoretical logic. The financial market press then just repeats the nonsense with very little scrutiny. But given many graphs are falling again, this Pavlovian-type response behaviour must be really doing their heads in. I have no sympathy.
The inflation scare rises on a number
The accelerating inflation narrative was given a boost last week when the US Bureau of Labour Statistics released the May 2021 their latest Consumer Price Index data.
In their ‘The Economics Daily’ article (June 16, 2021) – Consumer prices increase 5.0 percent for the year ended May 2021 – we learned that:
The Consumer Price Index for All Urban Consumers increased 5.0 percent from May 2020 to May 2021. Prices for food advanced 2.2 percent, while prices for energy increased 28.5 percent. Prices for all items less food and energy rose 3.8 percent for the year ended May 2021, the largest 12-month increase since the year ended June 1992.
This set off all the inflation scaremongers but they really should have been more circumspect.
At least the US Federal Reserve Monetary Committee didn’t really blink.
In their June 16, 2021 (released on the same data as the BLS data came out) – Federal Reserve issues FOMC statement – they maintained policy settings and repeated that it was “committed to … promoting its maximum employment and price stability goals.”
It announced that:
The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.
So no rush to an inflation is out of control narrative.
If inflation is accelerating why are long-term bond yields falling?
I gave an after-dinner address to a financial markets conference in Sydney last week and inflation was on everybody’s tongue during the dinner.
I was not surprised how quickly the narrative has turned in this way.
As I noted during the talk, the mainstream macroeconomics narrative is so far out of kilter with reality that proponents are just coping with the dissonance by going back to Pavlovian-type triggers.
See food, and eat it sort of stuff.
In their case, they have been seeing relatively large fiscal deficits and central bank asset purchasing programs and the only thing their defective model says about that sort of conjunction is rising interest rates and bond yields and inflation.
They cannot ‘understand’ the world in any other way.
So their only ‘contribution’ is to scream ‘rising inflation’.
Except that they have constant troubles dealing with the reality that confounds this response.
If the US economy was overheating and inflation was about to break out then why would long-term US bond yields be falling recently?
That is a question I posed to the dinner.
Have a look at the history of the US 10-year Treasury bond yields since the beginning of 2021.
You can get for all available maturities from the US Department of Treasury’s site – Daily Treasury Yield Curve Rates.
As the economy started to opened up a bit in February and sentiment improved, investors started to diversify their portfolios away from the risk-free Treasury bonds and yields rose a little.
Since mid-March, yields have flattened and now falling.
Why does this militate against the accelerating inflation narrative?
For those who are a little hazy about bond markets – or fixed income markets – a bond represents a future flow of cash returns which comprise regular ‘coupon’ (interest) payments that are fixed and the refund of the principal (face value) upon maturity.
Given there is no default or credit risk in holding a US government bond (or any bond issued by a currency-issuing nation) the only uncertainty that a investor faces is the path of inflation over the time that these cash payments are relevant.
I explained the relationship between movements in yields and prices of government bonds in this blog post – Whether there is a liquidity trap or not is irrelevant (July 6, 2011).
We also discuss the difference between primary and secondary markets in that post.
The simple rule is that when bond prices rises (fall) due to demand fluctuations, yields fall (rise).
Expectations of inflation become part of this dynamic because inflation reduces the real value of the these future cash flows.
So if investors expect that inflation is becoming an issue, then they will demand higher yields at the primary issue and will be prepared to pay less for outstanding bonds in the secondary market.
The higher the expected inflation, the higher the risk premium that will be built into required yields.
The bond investors closely watch the central bank’s monetary policy.
If they form the view that the policy interest rate that the central bank sets is too low, then they will up their inflation expectations (because they have been conditioned to believe this state will promote inflation), and demand higher yields at the investment maturities (long-term).
So the so-called yield curve, which depicts the current bond yields at all maturities will steepen.
Here are two visual depictions of the US Treasury yield curve.
The first surface graph shows the movements across the maturities between May 3, 2018 and June 18, 2021.
The second compares yield curves from the beginning of 2021 to June 18, 2021.
You can see in this graph (which is easier to see than in the previous surface graph) that over June (compare the thicker red and blue lines), the yield curve is flattening rather than steepening.
If inflation was about to runaway, then we should not expect to witness that sort of dynamic.
US real wages down 2.2 per cent
One day after the US Bureau of Labour Statistics released the US CPI data, they released (June 17, 2021) the published an article – Real average weekly earnings down 2.2 percent from May 2020 to May 2021 – in their excellent ‘The Economics Daily’ publication, which highlights the big data news of the day.
The BLS reported that:
Real (adjusted for inflation) average weekly earnings decreased 2.2 percent from May 2020 to May 2021. The change in real average weekly earnings resulted from real average hourly earnings decreasing 2.8 percent from May 2020 to May 2021. The change in real average hourly earnings, combined with an increase of 0.6 percent in the average workweek, resulted in the 2.2-percent decrease in real average weekly earnings over this period.
No wages explosion visible there.
Nominal wages grew by 2.6 per cent only.
In May 2020, average (nominal) hourly earnings were $US29.74 and a year later they had crept up to $US30.33 (Source).
Average weekly hours had risen from 34.7 to 34.9 hours.
Which brings me to the data again
Here at the latest FT Commodities graphs – for Metals and Agriculture and Lumber as at June 18, 2021.
Agriculture and Lumber
Here are two more detailed graphs – for Soybeans and Lumber – over 2021 to June 18, 2021.
Where are the screams of deflation?
I could have shown the movements in energy prices, which have been used to give credence to the accelerating inflation narrative.
Here is the OPEC – Basket Oil Price – from 2003 to June 17, 2021.
Sure enough oil prices have risen in the last few months as more cars are returning to the roads.
This is just a reversal of the price falls that occurred when the cars left the roads during the lockdown.
Note that the current level did not yet reach the pre-pandemic level and in recent days has started to taper off (see the next graph).
This graph shows the data from April 2021 to June 18, 2021.
I realise that it is easy to just be trapped by the data of the day, which doesn’t disclose underlying pressures and just reinforce one’s views.
And, to understand the inflationary potential one has to appreciate the levers that can be stimulated by some cost or demand triggers to generate a new inflationary spiral.
The point is that there are price pressures at present but I consider them to be transient as our economies and markets adjust to the massive disruptions in the global supply chains that have arisen during the pandemic.
And while in another era, these might have triggered a real wage-profit margin struggle between labour and capital, I cannot see the institutional machinery in place now to facilitate such a ‘battle of the markups’.
Trade unions are too weak and pernicious legislation has made it very hard for workers to fight for higher real wages.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.