Bond bids are passive
October 21, 2021
–Energy prices are one of the most easily observed indicators of inflation, and CLZ1 was at a new high late yesterday, trading 83.54, up 1.10. This morning a large chunk of that gain has been given back, with stock futures slightly lower as well. Late weakness yesterday in the long end. TYZ settled 130-205 but traded 14+ late and USZ1 settled 158-04 but slipped to 157-21. This morning they have both edged back up, closer to settles, but as of this note are still negative. The last couple of sessions have seen late selling in the long end, and US vol has firmed to the upper end of the recent range, around 9% in USZ as the attached chart shows. Selling pressure on bonds appears to outweigh bids; yesterday’s 20-yr auction saw underwhelming demand. I marked ten year treasury to inflation-indexed breakeven at a new recent high of 2.59%. Inflation expectations seem to be edging higher.
–Speeches in the last two days by both Waller and Quarles lean toward the view that inflation expectations have not become unmoored. However, comments from both suggest an asymmetric risk. From Waller: “That said, I am still greatly concerned about the upside risk that elevated inflation will not prove temporary.” And from Quarles: “But I see significant upside risks to my current inflation outlook.” How does one hedge against these risks? By buying insurance. Bond puts.
–Today features Jobless Claims expected 297k and Philly Fed expected 25 from 30.7. The most recent reading from the Atlanta Fed GDP Now estimates Q3 growth at only 0.5%, having been more like 3.7% through the first half of September. Now the question is, will the lull in growth due to shortages prove to be ‘transitory’?
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From Quarles (10/20/21)Going forward, the question is not only whether inflation will fall in the coming months, but also how far it will fall and if it will fall soon enough to avoid spurring a concerning rise in longer-term inflation expectations. I agree with my FOMC colleagues and most private forecasters that inflation likely will decline considerably next year from its currently very elevated rate. For instance, most of the September Summary of Economic Projections forecasts for PCE inflation in 2022 were between 1.9 and 2.3 percent, with a minimum of 1.7 percent and a maximum of 3.0 percent.3 But I see significant upside risks to my current inflation outlook.
From Waller (10/19/21)
This brings us to another question: Are inflation expectations anchored around our inflation target of 2 percent? Survey measures have shown a dramatic increase in inflation expectations over the past few months. The recent New York Fed measure has short- and medium-term inflation expectations at 5.3 percent and 4.2 percent, respectively. This is eye opening and a genuine cause for concern should households embed these expectations in wage demands. However, market-based measures of inflation expectations and the five-year inflation expectations from the New York Fed survey continue to be anchored near our 2 percent target.
That said, I am still greatly concerned about the upside risk that elevated inflation will not prove temporary.
