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Still Beating the Transitory Drum

October 18, 2021

Last Week This Morning

  • 10 Year Treasury retraced slightly to 1.57%
    • German bund ran up to -8bps before closing out at -0.16%
  • 2 Year Treasury up 1bp to 0.32%
  • LIBOR at 0.08%
  • SOFR at 0.05%
  • WTI hit $82/barrel, its highest level in 7 years and double its price a year ago
  • CPI and PPI basically came out as expected
  • Manufacturing data was weaker than expected
  • Retail sales were up dramatically, a good signal for GDP
  • JPM Chase credit card spending jumped 30%, but most balances are still being paid off each month


GDP – Delayed Gratification

Supply chain disruptions are causing a pricing surge, but they are also creating a drag on economic growth.  One of the primary reasons most economists are revising GDP forecasts lower is that dislocations are preventing purchases.  When ships are stuck in the harbor, you literally can’t buy those goods today.

Just as I’ve been arguing that stimulus pulled forward purchases (thus stealing from the future), the supply chain dislocations will delay purchases, thus elongating the recovery.



Inflation articles are everywhere.  Everyone is feeling it.  I get emails weekly explaining why I am wrong on inflation.  While Powell keeps beating the transitory drum, I think he may also need to tweak his messaging going forward to address these concerns.

I believe Powell is going to spend a lot of time telling the market that hiking rates wouldn’t resolve current pricing pressures.  The FOMC has an interest rate magic wand, but they don’t have a supply chain magic wand.  How, exactly, would rate hikes cool off the economy?

Inflation expectations, rather than actual inflation readings, will be a determining factor in the Fed’s messaging going forward.

Let’s consider how economists, consumers, and the market all expect inflation to remain within acceptable ranges.


Considering they all have similar training, most economists agree with FOMC forecasts for inflation to trend towards 2%.


Consumers surveyed put inflation at 2.8% in years 5-10 from today.  And while that feels high relative to recent memory, note that it’s well below what we expecting pre-financial crisis.

Source: Bloomberg Finance, LP


The market agrees.  The 5 year forward breakeven rate is 2.4%.

Source: Bloomberg Finance, LP


Should these expectations change, the Fed will have to address that.  But as long as the expectations are pricing in a trend towards 2.0%, Powell isn’t going to freak out over today’s inflation readings.

Just as importantly, Financial Conditions suggest Powell & Co can afford to be patient.  We are near all-time accommodative conditions.  If Treasurys climb, oil remains elevated, inflation/inflation expectations increase, etc., they will all tighten conditions without the Fed having to actually hike.

Source: Bloomberg Finance, LP

The Wu-Xia Shadow Fed Funds is deeply negative, around -1.8%.  That means conditions can absorb the equivalent of 7 hikes before the Fed actually hikes off of 0%.

Source: Bloomberg Finance, LP

In other words, the Fed can allow these other factors to naturally tighten financial conditions before it has to hike itself.  That’s a lot of tightening that could cool things off long before Powell makes his first move.

Plus, is the Fed really going to hike soon with Consumer Sentiment as low as it is right now?

Source: Bloomberg Finance, LP

Lastly, the velocity of money is still at an all-time low.  It doesn’t matter how much money has been printed until that money starts circulating.  For now, all that money is sitting on the sidelines.

Could this change?  Of course.  But until it does, it’s going to experience the type of pricing pressures that will cause the Fed to hike.


Week Ahead

Lots of data out this week, but nothing as significant as last week’s inflation data.

Monday brings China’s Q3 GDP, whose manufacturing industry is experiencing contraction again.  Keep an eye on this as a potential drag domestically in 2022.

Source: Bloomberg Finance, LP


Click to Open: The Pensford Letter PDF