Yields everywhere are rising too far, too fast: Could we expect them to settle down?

Outlook: Today we get housing starts and permits, but expectations are running low because of Omicron and bad weather. It’s not exactly an inspiring bit of data, anyway. In fact, the juicy data is from Canada, CPI today and retail sales on Friday. There is still chatter about a BoC hike next week. Remember the BoE can still surprise this week (Thursday), putting both of them ahead of the Fed.

Meanwhile, China is going the other way with rate cuts, if modestly. Bloomberg reports the PBOC is “pledging to use tools to spur the economy and ease credit stress as signs of a property slump worsens. The bank will roll out more policies to stabilize growth, front-load actions and make preemptive moves, Deputy Governor Liu Guoqiang said. Room for a further RRR cut still exists, but has narrowed, he added. Chinese banks are seen lowering the loan prime rate Thursday after the PBOC's rate cut Monday. Housing sales, land purchases and related financing are gradually returning to normal, another central bank official said.” Truth be told, no one knows how to judge the drop in momentum in the Chinese economy, especially when year-over-year growth is still wildly high for most factors (although the drop in retail sales could be a sign of a problem). Meanwhile, the property developer saga keeps developing, a kind of kicking the can down the road, possibly forever and never getting to a crisis. 

As a practical matter, the rise in yields everywhere, while belated considering we have had higher inflation data for a while now, is overkill. Rates/yields everywhere are rising too far, too fast, with the usual exceptions of Switzerland and Japan. We must expect them to settle down a bit in the next few days. That could put a dent in the dollar’s wild rally, but it won’t change the overall picture. Why the euro—the last man standing on rates—is not getting a sell-off is a puzzle.

Tidbit: The BofA Global Research monthly fund manager survey was released yesterday and many heed it --it had 374 participants with $1.2 trillion in assets under management. The findings include that hardly anyone (7 out of 100) sees recession this year, and inflation falling back—it may not be transitory but only 36% see it as permanent. This gang is sticking to three hikes, starting in April (it was July in the previous survey). And they all still like equities (and commodities) and don’t like bonds, golly. Consistent with recent history, a plurality say the Republicans will win the 2022 midterms. The Jan biggest “tail risks” are: “Hawkish central bank rate hikes” (44% of those polled), “Inflation” (21%), “Asset bubbles” (9%), “Global growth scare” (7%), “COVID-19 resurgence” (6%), “China credit contagion” (4%) and “US-China geopolitics” (3%).

What’s missing? Russia. Plus the priorities are weird. Supply shortages that persist are covered under inflation but only 21% see it as critical. Covid ranks way down, too. 

Inflation consists of more than one moving part. First is literally supply shortages as in the case of chips, especially for cars. Then there are the transportation tangles—ships, ports, trucks. Add to that unjustified price increases for consumer goods “because they can and nobody can prove lack of justification.” Already on its way it wage pressure. Bottom line, we’d say the fund managers are downplaying the risk of inflation and that can easily come back to bite them.

Also missing is gold. Recently we have seen some fancy talk about how gold should rise in sync with inflation as shown by the breakeven rate, which still fails to reflect a real return in financial assets, including TIPS. The WSJ has a table showing that the next maturing TIPS (April ’22) has a real return of -5.447%. The idea is that until the real return goes positive, gold will thrive and hang on to gains. It may not get to $2000 or much over it, but it’s not going to crash, either.

This seems reasonable, but is that how the gold market works? Demand for gold comes not only from the inflation-fearful but from jewelry and industrial uses, too. India and China are still the big buyers and presumably, that depends on their own growth rates, pretty high if losing some momentum. Then there is the alternative-investment universe of crypto that eats into demand for gold, not to mention interest in silver (which comes up every ten years or so, according to our mailbox) and other metals, now including rare earth. And in the end, while paper may not yield a real return now or in the near future, it’s the change toward a real return that counts, even without subtracting the cost of storage and insurance. 

The upcoming rate hikes everywhere (except China) are going to capture the imagination and drive people out of gold as well as some equities. Assuming inflation comes under control later this year, or seems to, we should probably assume gold moves down more or less pari passu with rate hikes. That’s the classic model and we’ll stick with it.

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