Blain’s Morning Porridge – July 22nd 2021 – Markets are ignoring the new inflation reality
“Nothing beside remains. Round the decay of that colossal wreck…”
This morning. Markets have entirely recovered after their wobble earlier this week, but it’s based on a simple belief: central banks will stand behind markets. Investors are increasingly convinced inflation threats are irrelevant – and they are wrong to do so. Inflation risks are growing from immediate climate change, the costs of rising environmental instability and inflation leaching out of financial assets into the real economy.
In between picking up phones and making important calls on a financial deal we’re working on – my day job – I’m going to be “fixed sights” on today’s ECB meeting and its likely consequences. I previewed the ECB strategy review and the limitations that achieving a compromise between member nations will create a few weeks ago. Rather than dwell on what might occur at today’s meeting – although I’m sure all the requisite back-room deals will have already have been done – I’m going to write it up tomorrow.
This morning..?
Well it’s pretty much same as, same as. The market has now recovered Monday’s crash with a two-day rally. I don’t believe any of the charts of stock price movements, or bond yield trends are telling us anything significant about what is happening in the real economy – they are going up because investors firmly believe global central banks will continue to juice global markets through unlimited interest rate distortion, QE and stimulus..
I must sound like a broken, jumping record – I’ve been warning on the consequence of monetary distortion for years…
As a result, I reject the 30-year old bond analysts telling us inflation is not a threat, because 10-year bond yields are so low. These very clever young folk have only ever worked in an environment where central bank distortions are the norm, rather than something extraordinary, unknown… which we thought would be a short-term market crutch rather than a permanent fixture.
I’ve now read so many opinions on inflation my eyes are starting to ache – it all depends on how you read the data. I completely accept the argument that some of the inflation inputs look “transitory”; mere supply side imbalances caused by factors such as hoarding and anticipation ahead of economies reopening, but there is no such thing as obvious in this swirling global economy.
Everyone on the short-term blip side of the inflation debate quotes how lumber prices spiked and then tumbled. Same effect in other critical commodities necessary for growth. However, I would simply note lumber prices are spiking again because of the accelerated weather-blown wildfire season starting early on the west coast.
There are two factors that make me suspect inflation is a much more dangerous force then this market perceives.
First, there is the immediate environment. It is going to change the global economy in terms of crushing productivity and returns – today, not in 2050.
The horrifying pictures of Chinese commuters trapped underground on a train after a year’s worth of rain fell in 3 days highlights just how much small changes in ocean temperatures have plunged global weather systems into turmoil.
I don’t particularly care if you are a climate change denier or a whale hugger – the evidence is becoming frighteningly clear. We have a problem. Heat Domes, Wildfires, Flooding, Powered up Monsoons, Coastal Erosion. You name it.. its happening and strip out the human misery, the reality is enormous bills to be paid.
It’s the costs that matter. They will have perverse economic effects. Munich Re reported natural disasters cost $166 bln in 2020. I googled the same question and found articles ranging from $95 bln to $280 bln.
What is immediately apparent is the number is rising. 2021 is shaping up to be an expensive year. For every disaster there is then the cost of rebuild and the effects of crowding out new capex and infrastructure spend. Insurance costs come out the bottom line – and will therefore directly impact productivity. Government amelioration of climate change will cost – and will be paid from taxation.. (Or NMT money printing – but more on that later..)
The effect of higher environment costs now (rather than the ones politicians hope to avoid in the future by zero-carbon policies in 30 years time) is critical. As the scale and scope of weather related disasters rise, the global economy will have to run faster just to stay still – a frightening thought when you read senior politicians like John Kerry arguing – with some justification – for a blanket ban on new oil, gas and coal.
The second factor is inflation is already here.
It’s already embedded in financial assets – sequestered in the rising prices of bonds and global equity. (Going to give myself and extra point for using sequestered without talking about Co2, darn.. just lost it..) That trapped inflation is now leaking into the real economy – just like a leaking barrel of toxic sludge dumped in a river. The mechanism is simple: investors holding financial assets are increasingly distrustful of valuations (which are impossibly high due to repressed interest rates), so they are switching from financial assets to real assets – like private equity and debt, property, and outright ownership of real assets.
We can see this clearly in the boom in SPACs, IPOs and rising property prices (even in commercial) that occurring despite the pandemic effect slowing the economy. Even planes are getting financed at levels right alongside pre-pandemic levels.
The inflation reality is it’s here and its going to rise. The recent inflation prints in the UK and US highlight that bonds are trading deep in negative real rates. (The Real Interest rate being interest rates less inflation.) That is unsustainable.
There is an element of “transitory” end-of-the-pandemic euphoric recovery inflation out there – but that’s just a distraction. Real inflation is coming from the cost the worrying wobbles in the environment are now generating, and the long-term leaching of buried financial asset inflation hitting the real economy…
That real inflation will change perceptions.
Yesterday UK NHS workers were told they are getting a three percent payrise, rather than the 1% the government originally proposed. The Unions are out there with demands for a blanket 15% rise. When one group of workers gets a rise… everyone else will demand similar…
Finally… Reserve currencies
I came across a brilliant graphic illustrating how reserve currencies have changed over the last 120 years from James Eagle on YouTube. Its well worth taking a moment to consider the past – and watch Sterling being replaced by the mighty Greenback and then remember the poem Ozymandias. Just saying….
Five Things to Read This Morning
FT – Credit Watch for UK officials over COVID loans as pandemic clouds persist
FT – The ECB strategy review is a missed opportunity
MP – An Open Letter To Virgin’s CEO
BBerg – The Saudi Prince of Oil vows to drill “every last molecule”
WSJ – Bond Rally Undercuts Inflation Fears
Out of time, and back to the day job
Bill Blain
Strategist, Shard Capital