A paraphrase of the Nilsson classic that was the theme tune to the movie Midnight Cowboy. Another version of the observation that some people are permanently on transmit and just don’t listen at all, implying that thinking is absent too.
Why is this relevant now? Everybody’s talking about inflation, but they are not thinking about the wider context. The common narrative is that inflation is falling, which is good, because it means the Fed can “pivot”. There a lot wrong with that observation. Inflation is falling, but mainly as a result of base effects ie the period you are comparing the inflation rate to was much higher back then, for example energy prices, oil and gas, have declined significantly. Recent data have highlighted the “stickiness” especially in services and wages are on the rise too. Everybody’s talking about a Fed pivot. Is there a chance of a pivot ahead? Yes, but far, far ahead.
A personal anecdote: my mobile bill is rising by 17.3% from next month. O2 tell me that inflation over the last 12 months has been 13.4% (does anyone have an index that confirms that – I can’t find one) and in their magnanimity they are adding on an extra 3.9% no doubt to cover their administrative costs of informing me of this egregious increase.
Falling inflation also means that the economy is slowing evidenced by the fall in commodity prices as demand slows. The yield curve is saying a recession is on the way if it isn’t here already. US 2% Treasury yields minus 10% yields are now close to a record minus 100 basis points and this in turn increases budget deficits (falling tax receipts and rising benefit payments) which in itself is inflationary; heads you lose tails you lose.
US Treasury 10 year yield minus US Treasury 2 year yield
Deeply in recessionary territory
Which is also why cutting rates into a recession doesn’t always have the desired effect. The Fed are truly between a rock and a hard place. Cut rates and you get inflation, keep raising rates and you get inflation too. This sounds like the playbook from emerging market economies where they try to keep afloat by debauching their currencies and end up with even higher inflation!
The talking heads also tell us that it can’t happen if you can print your own currency to pay your bills. In the past there has been a willingness by overseas countries to invest in US Treasuries. This was the old petrodollar regime whereby oil exporting countries, NB Saudi Arabia, recycled the dollars they received for oil back into the UST market. Today that is not happening any more as the BRICS have realised that by settling commodities in local currencies they no longer need to hold such large dollar reserves.
Who is going to buy the USTs that will need to be issued to pay the US interest rate and entitlements bills, which now exceed US Treasury tax receipts? Sounds like its going to have to be the Fed again. In the short term it would be an electric galvaniser for equity markets, commodities and gold, but it would also stoke the fires under the next inflationary impulse.
This is not an environment that seems to be particularly auspicious for bond investing whether it be sovereign debt or credit. In fact, in a recession, we would expect to see default rates rise, especially given the plethora of short term loans taken out at very low single digit rates over the past few years that will need refinancing at levels close to or in the double digit region.
Historically recessions have been good for bond markets as investors used to perceive them as a safe haven. Today with commodities being increasingly priced in local currencies with the ability to convert those currencies into gold, holding the barbarous relic is becoming a much safer option especially in terms of maintaining purchasing power, very much its long term attraction.
Jan 2023 RPI = 13.4%