Do last month’s woeful unemployment numbers undercut the mainstream theory that falling unemployment will lead to inflation?
The biggest financial story today is fear of inflation. Inflation has spooked the bond market and raised expectations that the Fed will soon have to raise interest rates to fight inflation.
Any increase in rates will also hurt stocks because stocks and bonds compete for investor dollars. If yields on bonds go up, prices on stocks will go down.
Growth stocks, like many leading tech stocks, are especially vulnerable to inflation because much of their valuation comes from future earnings. As inflation rises, the present value of their futures earnings can fall dramatically.
There’s no doubt that inflation expectations have been rising. This is especially true after a spike in the reported CPI core and non-core data on May 12. This inflation spike roiled the bond markets.
From the low yield of 0.508% on August 4, 2020, the 10-year note yield peaked at 1.745% on March 31, 2021, and hit a recent peak of 1.704% on May 13 (intraday) on the CPI news before backing down a bit to the current level (1.640%).
The dollar price of gold moved down in lockstep as the yield on the 10-year note rose. Still, there’s less than meets the eye in the recent increase in rates.
“Transitory”
As recently as November 4, 2018, the yield on the 10-year note was 3.238%. On November 4, 2019, the yield was 1.942%. The fact is today’s “high yields” are actually quite low and are much lower than the two interim peaks of the past three years.
In fact, real inflation is as elusive as it’s been for over a decade.
The surge in CPI reported on May 12 was driven predominately by base effects and energy prices. The Fed isn’t right often, but in this case, I believe they got it right. Year-over-year price gains off the low 2020 base are to be expected.
April 2020 marked one of the steepest output declines in U.S. history. Consumer prices plunged. In April 2021, many of those prices recovered, especially in travel, airfares, hotels, restaurants and other services that were almost completely shut down in 2020.
They are also transitory because the 2020 output collapse was transitory. As we move into the third quarter of 2021, the new base will reflect the strong growth in Q3 2020. That’s a much steeper hill to climb for inflation metrics.
Inflation will come down sharply, and the ten-year note yield will come down with it. Gold will rally, and stocks will breathe a sigh of relief.
This does not mean all is well in the stock market. Bubble dynamics persist, although it’s impossible to know exactly when a bubble will burst.
But, at least in the short run, inflation fears are a false alarm. Inflation will arrive eventually, maybe in 2022 or later, but for now, the disinflationary dynamic is fully intact.
Don’t believe the hype.
- Source, James Rickards
