‘Reflation’ Breakdown, This Time Without Interruption

By Jeffrey Snider of Alhambra

In the early trading on Friday, it looked as if “reflation” might break down entirely. The flurry of information seemed to be uniformly bad, from Syria to payrolls there wasn’t much for optimism to remain relevant. All of a sudden, however, it all reversed so that trading in the latter part of the day was as if related to an entirely differently world.

Such trading reversals are not unheard of, and usually they are a sign that a trend or established intermediate direction might be ready to go back the other way. Whether buying or selling, an intraday capitulation can be a signal of a temporary end.

Though that is how it worked out in the raw data streams of eurodollars, bond yields, and most especially the Japanese yen, there was something different about it all that to my view suggested not a meaningful intraday reversal but instead an artificial intrusion (subscription required).

Thus, if “reflation” breaks down more completely, it would be China that might experience the most in the backlash from it. Not to depart into the realm of conspiracy, but who might have had motive to intervene in “dollars” on Friday? It might have been the market all on its own deciding to toggle risk despite all the breakdowns being presented at that moment, or maybe it was the hint of “somebody” trying to keep alive at least the balance that has persisted since December because if nothing else volatility is everyone’s enemy (except bond bulls and eurodollar longs).

It turned out to be (so far) just a one-day reprieve, as yesterday trading slid back against “reflation” before today’s session put the exclamation point on it. Eurodollar futures are up across the board, including more contracts toward the front end. Most of the buying attention is still focused on 2019-2022, the very maturities that define best longer run expectations. Since mid-March, significant flattening all over again.

The latest curve, despite an additional “rate hike” in between, has submerged below the last flat point on February 8. The current price of the June 2020’s is today only slightly less than the intraday high on Friday, again suggesting the breakdown of “reflation” and therefore whatever little topside probability was included in it.

Continue reading ‘Reflation’ Breakdown, This Time Without Interruption

Consensus Inflation (Again)

By Jeffrey Snider of Alhambra

Why did Mario Draghi appeal to NIRP in June 2014? After all, expectations at the time were for a strengthening recovery not just in Europe but all over the world. There were some concerns lingering over currency “irregularities” in 2013 but primarily related to EM’s and not the EU which had emerged from re-recession. The consensus at that time was full recovery not additional “stimulus.” From Bloomberg in January 2014:

Among countries using the euro, economic confidence rose in December to a 2 1/2-year high after an 18-month recession ended in the second quarter.

It was common to find survey data in particular reflecting the economic possibilities of 2011 or 2010. Not only was growth apparently accelerating it was, at least expressed in the mainstream, broad-based. From Bloomberg in September 2013 with regard to China:

“Growth in China has seemingly already passed the trough and looks set to recover further in the second half,” the OECD said.

From Bloomberg in December 2013 relating mainstream US economic predictions:

“This economy is getting ready to kick it up a notch,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, who correctly forecast the orders gain. “Consumers are feeling confident enough to buy the biggest of big-ticket items, the family home, and companies are seeing enough demand to buy equipment at close to record levels.”

From the consensus view of the global what the ECB did in the middle of 2014 doesn’t appear to make much sense, particularly when compared to the Federal Reserve that had shifted its narrative toward “overheating.” Why the additional European “stimulus” at that time? And why was it NIRP first rather than full QE or even other QE-like programs?

The answer to both questions was inflation. Despite uniform and ubiquitous predictions for a strengthening, confident recovery the Continent’s HICP was set to decelerate against them. From an already low level, it was just 1.4% in 2013, Europe’s central bank feared too little margin in consumer prices when in March 2014 the ECB staff projected just 1.0% inflation for calendar year 2014.

Not wanting to risk a fall below that level, the ECB decided it had to act. Though they may have preferred QE right from the start, they hesitated to go that route because of bond rates. Recognizing that interest rates are not always the “stimulus” they are claimed to be, a large program specifically buying more sovereign debt threatened to make the inflation problem, from the perspective of policymakers, worse.

Instead, they thought NIRP would help as a gentle nudge for banks to mobilize some of the useless bank reserves. The expected increase in bank lending could then work with the bond market to transmit inflation expectations without the fetter of ECB purchases and what economists believe is their effect on interest rates (they think them lower due to monetary policy). It was supposed to result in the best of all worlds, the broad-based recovery with inflation expectations and then inflation itself confirming it.

Unfortunately because orthodox Economics is predicated on such a small knowledge base of mostly past correlations, almost nothing went right from the moment the ECB acted. Inflation only continued to fall, as did bond rates anyway, and by the end of 2014 even the idea of recovery was being rethought (though reluctantly and only as a small probability at first).

Continue reading Consensus Inflation (Again)

‘Real’ Performance Comparison

By Steve Saville

Inserted below is a chart that compares the long-term inflation-adjusted (IA) performances of several markets. This chart makes some interesting points, such as:

1) Market volatility increased dramatically in the early-1970s when the current monetary system was introduced. This shows that the generally higher levels of monetary inflation and the larger variations in the rate of monetary inflation that occurred after the official link to gold was abandoned didn’t only affect nominal prices. Real prices were affected in a big way and boom-bust oscillations were hugely amplified. As an aside, economists of the Keynesian School are oblivious to the swings in relative ‘real’ prices caused by monetary inflation and the depressing effects that these policy-induced price swings have on economic progress.

2) Commodities in general (the green line on the chart) experienced much smaller performance oscillations than the two ‘monetary’ commodities (gold and silver). This is consistent with my view that there aren’t really any long-term broad-based commodity bull markets, just gold bull markets driven by monetary distortions in which most commodities end up participating. The “commodity super-cycle” has always been a fictional story.

3) Apart from the Commodity Index (GNX), the markets and indices included in the chart have taken turns in leading the real performance comparison. The chart shows that gold and the Dow Industrials Index are the current leaders with nearly-identical percentage gains since the chart’s January-1959 starting point. Note, however, that if dividends were included, that is, if total returns were considered, the Dow would currently have a significant lead.


Chart Notes:

a) I use a method of adjusting for the effects of US$ inflation that was first described in a 2010 article. This method isn’t reliable over periods of two years or less, but it should come close to reflecting reality over the long term.

b) To make it easier to compare relative performance, the January-1959 starting value of each of the markets included in the above chart was set to 100. In other words, the chart shows performance assuming that each market started at 100.

c) The monthly performance of the scaled IA silver price peaked at more than 2600 in early-1980, but for the sake of clarity the chart’s maximum Y-axis value was set to 1500. In other words, the chart doesn’t show the full extent of the early-1980 upward spike in the IA silver price.

d) The commodity index (the green line on the chart) uses CRB Index data up to 1992 and Goldman Sachs Spot Commodity Index (GNX) data thereafter.

I’m No Chart Whiz, But About That Whole Reflation Thing…

By Heisenberg

Ok, so this comes with the usual caveat about me not being the chart wizard that some other folks are, but this is starting to look like a sh*t show from where I’m sitting in terms of the reflation narrative….

Since the Fed:


Long bond (30Y yield dropped below 3% on initial report of London terror attack):


USDJPY (dollar fell for a sixth day; USD/JPY dropped to 110.73):


Brent (-32c to end session at $50.64, below 200-day MA; price touched $49.71; first trades below $50 since November):


Small caps (the damage to this popular Trump trade was of course done yesterday):


Or, in cartoon form…


Inflation, But Only Where it Hurts

By Jeffrey Snider of Alhambra

The Consumer Price Index increased 2.74% in February 2017 over February 2016. That was the highest inflation rate registered in this format since February 2012. As has been the case for the past three months, the acceleration of headline inflation is due almost exclusively to the sharp increase in oil prices as compared to the lowest levels last year (base effects). It is the only part of the CPI report which captures anything like it.

The energy price index was up 15.6% year-over-year, compared to an 11.1% increase in January. The gamma of energy and therefore the CPI is already fading, with oil prices having been stuck at $52-$54 during the months of January and February. If WTI remains about where it is now, around $48, the current month (March) will be the last to feature any significant acceleration from oil.

The other parts of the CPI are as they have been consistently throughout. The “core” index, CPI less food and energy, was up 2.2% in February. It was the fifteenth straight month where the core increase was one of 2.1%, 2.2%, or 2.3%. In what is probably the best indication of inflation stripped of energy, the last time the core rate accelerated even slightly was during the second half of 2015.

Continue reading Inflation, But Only Where it Hurts

Trader Warns: Fed Meeting Will be “Death Knell” for Reflation Trades

By Heisenberg

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.

Via Bloomberg

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

Good Models and Bad Models

By Michael Ashton

I have recently begun to spend a fair amount of time explaining the difference between a “good model” and a “bad model;” it seemed to me that this was a reasonable topic to put on the blog.

The difference between a good model and a bad model isn’t as obvious as it seems. Many people think that a “good model” is one that makes correct predictions, and a “bad model” is one that makes bad predictions. But that is not the case, and understanding why it isn’t the case is important for economists and econometricians. Frankly, I suspect that many economists can’t articulate the difference between a good model and a bad model…and that’s why we have so many bad models floating around.

The definition is simple. A good model is one which makes good predictions if high-quality inputs are given to the model; a bad model is one in which even the correct inputs doesn’t result in good predictions. At the limit, a model that produces predictions that are insensitive to the quality of the inputs – that is, whose predictions are just as accurate no matter what the inputs are – is pure superstition.

For example, a model of the weather that depends on casting chicken bones and rat entrails is a pretty bad model since the arrangement of such articles is not likely to bear upon the likelihood of rain. On the other hand, a model used to forecast the price of oil in five years as a function of the supply and demand of oil in five years is probably an excellent model, even though it isn’t likely to be accurate because those are difficult inputs to know. One feature of a good model, then, is that the forecaster’s attention should shift to the forecasting of the inputs.

This distinction is relevant to the current state of practical economics because of the enormous difference in the quality of “Keynesian” models (such as the expectations-augmented Phillips curve approach) and of monetarist models. The simplest such monetarist model is shown below. It relates the GDP-adjusted quantity of money to the level of prices.

Continue reading Good Models and Bad Models

So Yeeahhh… About That Reflation Thing

By Heisenberg




As Bloomberg writes:

While investors may return to the reflation narrative again, it’ll take more than a few political speeches to get them there. For now, traders are losing faith in rapid reflation. It’s likely they’ll continue backing away from the assets that benefited most from this concept until there are concrete developments that push them back to believing again.

Can Someone Please Explain This Schatz?!

By Heisenberg

Earlier this morning, I noted that the March (get it?) higher in US 2Y yields looks pretty amusing if you plot it against near record low German 2Y yields.

Indeed, as noted here on numerous occasions, there’s a push-pull dynamic between the US and Germany when it comes to global rates. Have a look:



Of course Schatz yields have blown out since hitting record lows late last week. Indeed, between hawkish Fed commentary, what counts as “upbeat” Trump messaging, and, importantly, rising inflation in Germany…

Continue reading Can Someone Please Explain This Schatz?!

China Credit and Global Inflationary Dynamics

By Doug Noland

Credit Bubble Bulletin: China Credit and Global Inflationary Dynamics

February 14 – Bloomberg: “China added more credit last month than the equivalent of Swedish or Polish economic output, revving up growth and supporting prices but also fueling concerns about the sustainability of such a spree. Aggregate financing, the broadest measure of new credit, climbed to a record 3.74 trillion yuan ($545bn) in January… New yuan loans rose to a one-year high of 2.03 trillion yuan, less than the 2.44 trillion yuan estimate. The credit surge highlights the challenges facing Chinese policy makers as they seek to balance ensuring steady growth with curbing excess leverage in the financial system.”

Like so many things in The World of Finance, we’re all numb to Chinese Credit data: Broad Credit growth expanded a record $545 billion in the month of January, about a quarter above estimates. Amazingly, last month’s Chinese Credit bonanza exceeded even January 2016’s epic Credit onslaught by 8%. Moreover, as Bloomberg noted, “The main categories of shadow finance all increased significantly. Bankers acceptances — a bank-backed guarantee for future payment — soared to 613.1 billion yuan from 158.9 billion yuan the prior month.”

February 14 – Bloomberg: “China’s shadow banking is back in full swing. Off-balance sheet lending surged by a record 1.2 trillion yuan ($175bn) last month… Efforts by the People’s Bank of China to curb fresh lending may have prompted banks to book some loan transactions as shadow credit, according to Sanford C. Bernstein.”

Yet this was no one-month wonder. China’s aggregate Credit (excluding the government sector) expanded a record $1.05 TN over the past three months, led by a resurgence in “shadow” lending. According to Bloomberg data, China’s shadow finance expanded $350 over the past three months (Nov. through Jan.), up three-fold from the comparable year ago period.

Friday from Bloomberg: “White House Chaos Doesn’t Bother the Stock Market.” Many are confounded by stock market resilience in the face of Washington discord. Perhaps it’s because global liquidity and price dynamics are currently dictated by China, the BOJ and the ECB – rather than Washington and New York. Eurozone and Japanese QE operations continue to add about $150bn of new liquidity each month. Meanwhile, Chinese Credit growth has accelerated from last year’s record $3.0 TN (plus) annual expansion.

February 14 – Bloomberg (Malcolm Scott and Christopher Anstey): “Forget about Donald Trump. The global reflation trade may have another driver that proves to be more durable: China’s rebounding factory prices. The producer price index has staged a 10 percentage-point turnaround in the past 10 months, posting for January a 6.9% jump from a year earlier. Though much of that reflects a rebound in commodity prices including iron ore and oil, China’s economic stabilization and its efforts to shutter surplus capacity are also having an impact.”

China’s January PPI index posted a stronger-than-expected 6.9% y-o-y increase. A year ago – back in January 2016 – y-o-y producer price inflation was a negative 5.3%.  It’s worth noting that China’s y-o-y PPI bottomed in December 2015 at negative 5.9%, the greatest downward price pressure since 2009. In contrast, last month’s y-o-y PPI jump was the strongest since August 2011 (7.3%). China’s remarkable one-year inflationary turnaround was not isolated in producer prices. China’s 2.5% January (y-o-y) CPI increase was up from the year ago 1.8%, matching the peak in 2014.

There are two contrasting analyses of China’s record January Credit growth. The consensus view holds that Chinese officials basically control Credit growth, and a big January confirms that Beijing will ensure/tolerate the ongoing rapid Credit expansion required to meet its 6.5% 2017 growth target (and hold Bubble collapse at bay). This is viewed as constructive for the global reflation view, constructive for global growth and constructive for global risk markets. Chinese tightening measures remain the timid “lean against the wind” variety, measures that at this point pose minimal overall risk to Chinese financial and economic booms.

An opposing view, one I adhere to, questions whether Chinese officials are really on top of extraordinary happenings throughout Chinese finance, let alone in control of system Credit expansion. Years of explosive growth in Credit, institutions and myriad types of instruments and financial intermediation have created what I suspect is a regulatory nightmare. I seriously doubt that PBOC officials take comfort from $1.0 TN of non-government Credit growth over just the past three months.

Continue reading China Credit and Global Inflationary Dynamics