Inflation tends to lead to interest rates moving higher and invariably the prices of US treasury bonds move inversely to yields (i.e. when rates increase, or are expected to increase, bond prices fall).
This expectation of inflation is currently one of the most widely held beliefs across capital markets (there are currently more bets on the price of bonds falling than there have been for some time).
However, we’re not so sure that this is right – or rather I’m not sure that there exists yet any proof that this is the case.
The expectation seems to be based on the belief that once COVID has gone away (through vaccinations/herd immunity) this will unleash a wave of ‘pent-up’ consumer (and business) spending causing a strong rebound in economic growth that will lead to dramatic reductions in unemployment that will result in more Americans having higher levels of disposable income that in turn will result in higher consumption, that will lead to even more employment and therefore a tighter labour market and higher wages and even higher levels of economic activity that ultimately result in inflation because of these higher wages and this higher demand for goods & services.
Superficially that sounds plausible but I have several issues with this, partly because it’s an oversimplified explanation of how inflation works but also the latest official US unemployment data(1) indicates that the ethnic groups that have been hit hardest are those with the lowest average income levels ( Black/African Americans, followed by Hispanic/Latinos).
So, it’s not unreasonable to infer that the lowest paid & poorest Americans have suffered the greatest losses of jobs and incomes. This has a significant impact on the economic performance of America going forwards as the lowest wage earners spend the highest proportion of their income and therefore this broad socio-economic group has the greatest sensitivity to consume more – each Dollar in the hands of the poorest in society is more likely to spent on economic activity than in the hands of the wealthiest (2)
So, in short, the direction of travel of recovery in the USA is largely dependent upon the recovery in relatively low paid jobs, that have been the ones most impacted by the COVID downturn.
It seems to be widely accepted that this is just a cocked spring that once released will rebound way beyond the previous level BUT here are a couple of points to take into account:
MANY OF THE ‘MISSING JOBS’ ARE IN RETAIL, TRANSPORTATION, CONSTRUCTION & LEISURE/HOSPITALITY (3)
It seems widely accepted that, having been deprived of holidays, dining out, shopping experiences, that people will flock back to these channels and also buying new houses to save the beaten up construction sector and make up for lost time. That might be the case, especially as in aggregate America has built up household savings during the lockdown.
But we suspect that those in the highest wealth and income categories (where savings have generally increased significantly) might have less pent-up demand – the sales of the highest profile luxury brands have generally held up reasonably well, we don’t see a huge element of catch up to act as a catalyst for the likes of LVMH or Hermes.
In the middle ground, we expect that consumers exposed to some psychological effects of COVID have become very price tag oriented – discounted stock clearance might be essential for retailers’ cash flows but not great for margins if retailers have to compete aggressively for every Dollar spent.
At the lowest income levels, there has been a depletion of savings/increase in debt levels and therefore we think low income consumers will be extremely cautious and have little additional spending, despite the much touted stimulus programme.
Add these impacts together – no surge in luxury, a volume surge, a retail margin squeeze in middle ground and too many consumers with limited spending power and this doesn’t seem likely to lead to a hiring rush. We’d apply a similar expectation to leisure and to travel and also to new home sales.
Also, we note that all consumers have changed their habits during the lockdown – whether buying goods online, exercising from home, working from home or ordering at home dining. (4) We find it hard to square this change in consumption habits with expectations of the great re-opening leading to a huge re-hiring. Can we really expect there to be something like the 2.5 million jobs created to take these 4 sectors back to where they were pre-COVID? That seems a huge contradiction to us. As well as the 2.5 million in these 4 sectors who became officially unemployed in the last 12 months, many of the other 1.5 million official non-farm employees who lost their jobs during this time and have been unable to find employment are also dependent on these 4 sectors. If we don’t go back to the same lifestyle habits as before, then these 4 million of these jobs are unlikely to return.
What’s more, as of last month, there were a further 6.9 million Americans classified as ‘not in the labor [sic] force’ but seeking employment. This may include some of the 3-4 million new workers who would have joined the workforce in 2020-21 but haven’t been able to, but there is an employment crisis with up to 20 million Americans out of work.
If the majority of these can find gainful employment and add to consumption, this would have a huge impact. But there are currently no signs that this is happening.
It doesn’t just seem to be an issue of confidence – if we look at the pre-COVID official unemployment, we can see that the worst performing employment sectors were leisure/hospitality, construction, professional services, non-durable goods and retail. The weakness in the US economy didn’t begin with COVID and therefore it seems to be a leap of faith to suggest that herd immunity and mass vaccinisation will cure that weakness.
We have repeatedly said that we think that there will be volatility in most data in the coming months, including inflation data but maybe the clearest signal that we’re not yet seeing recovery is that the only inflation that is rearing its head is at producer inflation at factory gates. This strikes us as supply driven and historically tends to be transient unless accompanied by higher prices on the High Street (Consumer Price Inflation or CPI), which tends to better reflect surging demand. Right now, this isn’t happening-
We’ll keep a close watch for it but right now, it seems that the best investment opportunities might be to challenge or at least hedge against the consensus view that boom times are just around the corner, that inflation will follow, that interest rates will rise and that treasury bond prices should be lower to reflect this. Current prices could offer excellent opportunities, despite the strongly held consensus to the contrary because at this stage, we can find little or no real empirical evidence to support that consensus view.
Notes
(1)
For a better explanation of what really causes inflation see- An MMT response on what causes inflation | Financial Times (ft.com)
The latest US employment data reveal the following
(2)
For anyone still clinging to any notions of ‘trickle down economics’, this is a good satirical, Australian rejoinder https://twitter.com/i/status/1340881792266428417 ).
(3)
(4)
MBMG Investment Advisory is licensed by the Securities and Exchange Commission of Thailand as an Investment Advisor under licence number Dor 06-0055-21.
For more information and to speak with our advisor, please contact us at info@mbmg-investment.com or call on +66 2 665 2534.
About the Author:
Paul Gambles is licensed by the SEC as both a Securities Fundamental Investment Analyst and an Investment Planner.
Disclaimers:
1. While every effort has been made to ensure that the information contained herein is correct, MBMG Investment Advisory cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of MBMG Investment Advisory. Views and opinions expressed herein may change with market conditions and should not be used in isolation.
2. Please ensure you understand the nature of the products, return conditions and risks before making any investment decision.
3. An investment is not a deposit, it carries investment risk. Investors are encouraged to make an investment only when investing in such an asset corresponds with their own objectives and only after they have acknowledge all risks and have been informed that the return may be more or less than the initial sum.