The relentless bid under the market persisted this week with stocks and bonds advancing. The rally in equities isn’t exactly shocking given underlying growth dynamics (both economic and earnings growth). But the rally in bond prices has taken a lot of people by surprise.
There was a good amount of trepidation among bond investors going into this week due to the scheduled release of the consumer price index (CPI) for May. Everyone knew it was going to come in hot, but how hot? Turns out prices accelerated by the most in nearly 13 years.
Specifically, the CPI printed year-over-year growth of +5% (chart below). That represents the highest rate of inflation since the figure hit +5.4% in August 2008. The core CPI, which strips out food and energy, rose +3.8% in May, the most since 1992.
What continues to stand out in the inflation data is the surge in car prices. The subcomponent for used cars and trucks was up +7.3% in May and are up roughly +30% year-over-year, as you can see below.
The jump in car prices accounts for roughly half the monthly increase in the overall prices level.
And as we’ve talked about in previous letters, this gets to the heart of the permanent versus transitory inflation debate. Are car prices going to increase another 30% in the year to come? Are employees going to start demanding higher wages because car prices are soaring?
The bond market is voting no on both questions. For example, despite the hot inflation report, yields on the 10-year Treasury bond saw their biggest weekly drop in a year. Furthermore, the market’s expectation for inflation over the coming 10-years actually dipped this week, as you can see below.
Before we rush to judge, the bond market isn’t necessarily totally out to lunch. Commodity prices, which have been on a tear since last year, have come off the boil (with the exception of oil). Take lumber:
Or iron ore:
Bond investors are thinking that this will feed through into moderating inflation numbers in the months to comes, especially as the year-over-year comps get more challenging for the higher inflation trade.
Finally, we shouldn’t talk about bond yields without touching on the elephant in the room. The Fed is still buying a ton of them. The Fed’s balance sheet hit a cool $8 trillion this week.
The next big event for bond investors will be the Fed meeting next week. What will they say about asset purchases and the possibility of tapering their buying by year-end? Seems like they will talk about, but how forcefully will Powell address it in his press conference? It still appears the Fed won’t want to rock any boats over the summer.
Charts We Found Interesting
1. Seattle is the first major American city to fully vaccinate 70% of its residents 12 years-old and older. Seattle has surpassed San Francisco which had been leading the country in vaccinations and Vermont which is leading all states in vaccination rates.
2. The number of unfilled job openings is at an all-time high.
3. For all the fuss, a global minimum tax won’t dent corporate profitability much.
4. The current gap between 10yr US yields (c.1.5%) and US CPI (5.0%) is -3.5%. This is the largest gap since 1980, and has only been surpassed for 10 months in the last 70 years, all of which were in 1974, 1975 or 1980.
5. Porsche buyers are switching to electric. You can’t help but wonder if we will see something similar when the electric version of the F-150 hits the streets.
6. Lake Mead is plumbing all-time lows – the water level is falling roughly 1.7 inches a day.
7. Sometimes you get the sense Bill Watterson wasn’t so much a cartoonist as he was an oracle.
Have a good weekend.
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