Dammit Mark, didn’t you learn anything from Goldman’s overnight note on commodities?
When reality doesn’t reflect what you think it should, you just cast that reality aside and posit your own reality.
That’s how this works.
It’s just like Goldman said, “the lack of hard evidence” should never get in the way of a good trade reco. Which is why instead of admitting that maybe the plunge in commodities is exactly what it looks like – a deflationary bombshell – it’s actually something different because “there are two reflation themes at work.” Only the one that doesn’t matter got hit. From Goldman:
We reiterate our constructive outlook as activity levels drive the reflation themes, not growth rates. The 5% sell off in commodities (-3% metals, -7% energy) this past week would suggest that the global reflation trade has taken a step back. However, we believe that this sell off revealed that there are two reflation themes at work – a manufacturing reflation theme and a service reflation theme. Until this week’s commodity rout these two themes were very hard to identify separately. The manufacturing reflation theme is China- and OPEC-centered and is reflected in tradable goods prices, of which commodities are at the core. In contrast, the service reflation theme is US- and European-centered in the non-tradable sector. Despite the commodity rout, the service reflation theme was un-phased this past week with Friday’s US labor report reinforcing the trend as well as comments out of the ECB about reflation in Europe (see Exhibits 1 & 2).
See? Again: there were actually two reflation(s) at play here. We just didn’t know that until last week.
That folks, is your full retard analyst excerpt of the day right there. And former FX trader Mark Cudmore isn’t buying it anymore than I am.
Below, find some excellent color from Cudmore on everything said above.
Thanks to commodities, the Fed meeting is more likely to be the death knell for reflation trades rather than mark their moment of victory.
- This week is set to provide confirmation that we’re in the midst of a true tightening cycle in the U.S., with rate hikes in consecutive quarters for the first time since 2006
- 10-year Treasury yields hover just below the two-year high, but I don’t see them breaking higher in an environment where commodity prices are plunging
- Oil was just the latest victim last week, with prices falling the most in four months. The broader Bloomberg Commodity Index topped out a month ago, with everything from metals to agricultural goods turning sharply lower since then
- This undermines the reflation trade in three ways. Most directly, it’s hard for inflation to keep accelerating when input prices are slumping
- It also suggests that real demand is not growing as quickly as hoped, which provides caution on economic optimism. Finally, while cheaper commodity prices are a long-term positive for economic growth, the more immediate wealth/portfolio effect is negative
- Price data from the U.S. this month has validated the suspicion that inflation is not rising as fast as forecast, with the PCE deflator coming in below expectations
- This isn’t an environment that supports much higher long- term yields. Add in the context that speculative short positions in Treasuries remain near record levels and it appears to be a market ripe for a squeeze