It has been a long time since I’ve posted, and in the meantime the topics to cover have been stacking up. My lack of writing has certainly not been for lack of topics but rather for a lack of time. So: heartfelt apologies that this article will feel a lot like a brain dump.
A lot of what I want to write about today was provoked/involves last week. But one item I wanted to quickly point out is more stale than that and yet worth pointing out. It seems astounding, but in early August Japan’s Ministry of Health, Labour, and Welfare reported the largest nominal wage increase in 1997. (See chart, source Bloomberg). This month there was a correction, but the trend does appear firmly upward. This is a good point for me to add the reminder that wages tend to follow inflation rather than lead it. But I believe Japanese JGBis are a tremendous long-tail opportunity, priced with almost no inflation implied in the price…but if there is any developed country with a potential long-tail inflation outcome that’s possible, it is Japan. I think, in fact, that if you asked me to pick one developed country that would be the first to have “uncomfortable” levels of inflation, it would be Japan. So dramatically out-of-consensus numbers like these wage figures ought to be filed away mentally.
While readers are still reeling from the fact that I just said that Japan is going to be the first country that has uncomfortable inflation, let me talk about last week. I had four inflation-related appearances on the holiday-shortened week (! is that an indicator? A contrary indicator?), but two that I want to take special note of. The first of these was a segment on Bloomberg in which we talked about how to hedge college tuition inflation and about the S&P Target Tuition Inflation Index (which my company Enduring Investments designed). I think the opportunity to hedge this specific risk, and to create products that help people hedge their exposure to higher tuition costs, is hugely important and my company continues to work to figure out the best way and the best partner with whom to deploy such an investment product. The Bloomberg piece is a very good segment.
I spent most of Wednesday at the Real Return XII conference organized by Euromoney Conferences (who also published one of my articles about real assets, in a nice glossy form). I think this is the longest continually-running inflation conference in the US and it’s always nice to see old friends from the inflation world. Here are a couple of quick impressions from the conference:
- There were a couple of large hedge funds in attendance. But they seem to be looking at the inflation markets as a place they can make macro bets, not one where they can take advantage of the massive mispricings. That’s good news for the rest of us.
- St. Louis Fed President James Bullard gave a speech about the outlook for inflation. What really stood out for me is that he, and the Fed in general, put enormous faith in market signals. The fact that inflation breakevens haven’t broken to new highs recently carried a lot of weight with Dr. Bullard, for example. I find it incredible that the Fed is actually looking to fixed-income markets for information – the same fixed-income markets that have been completely polluted by the Fed’s dominating of the float. In what way are breakevens being established in a free market when the Treasury owns trillions of the bonds??
- Bullard is much more concerned about recession than inflation. The fact that they can both occur simultaneously is not something that carries any weight at the Fed – their models simply can’t produce such an outcome. Oddly, on the same day Neel Kashkari said in an interview “We say that we have a symmetric view of inflation. We don’t mind if it’s 2.1 or 1.9, but in our practice, in what we actually do, we are much more worried about high inflation than we are low inflation. And I think that that is the scar from the 1970s.” That’s ludicrous, by the way – there is no way in the world that the Fed would have done the second and third QEs, with the recession far in the rear view mirror, if the Fed was more concerned with high inflation. Certainly, Bullard showed no signs of even the slightest concern that inflation would poke much above 2%, much less 3%.
- In general, the economists at the conference – remember, this is a conference for people involved in inflation markets – were uniform in their expectation that inflation is going nowhere fast. I heard demographics blamed (although current demographics, indicating a leftward shift of the supply curve, are actually inflationary it is a point of faith among some economists that inflation drops when the number of workers declines. It’s actually a Marxist view of the economic cycle but I don’t think they see it that way). I heard technology blamed, even though there’s nothing particularly modern about technological advance. Economists speaking at the conference were of the opinion that the current trade war would cause a one-time increase in inflation of between 0.2%-0.4% (depending on who was speaking), which would then pass out of the data, and thought the bigger effect was recessionary and would push inflation lower. Where did these people learn economics? “Comparative advantage” and the gain from trade is, I suppose, somewhat new…some guy named David Ricardo more than two centuries ago developed the idea, if I recall correctly…so perhaps they don’t understand that the loss from trade is a real thing, and not just a growth thing. Finally, a phrase I heard several times was “the Fed will not let inflation get out of hand.” This platitude was uttered without any apparent irony deriving from the fact that the Fed has been trying to push inflation up for a decade and has been unable to do so, but the speakers are assuming the same Fed can make inflation stick at the target like an arrow quivering in the bullseye once it reaches the target as if fired by some dead-eye monetary Robin Hood. Um, maybe.
- I marveled at the apparent unanimity of this conclusion despite the fact that these economists were surely employing different models. But then I think I hit on the reason why. If you built any economic model in the last two decades, a key characteristic of the model had to be that it predicted inflation would be very low and very stable no matter what other characteristics it had. If it had that prediction as an output, then it perfectly predicted the last quarter-century. It’s like designing a technical trading model: if you design one that had you ‘out’ of the 1987 stock market crash, even if it was because of the phase of the moon or the number of times the word “chocolate” appeared in the New York Times, then your trading model looks better than one that doesn’t include that “factor.” I think all mainstream economists today are using models that have essentially been trained on dimensionless inflation data. That doesn’t make them good – it means they have almost no predictive power when it comes to inflation.
This article is already getting long, so I am going to leave out for now the idea I mentioned to someone who works for the Fed’s Open Market Desk. But it’s really cool and I’ll write about it at some point soon. It’s an idea that would simultaneously be really helpful for investors and help the Fed reduce a balance sheet that they claim to be happy with but we all really know they wish they could reduce.
So I’ll move past last week and close with one final off-the-wall observation. I was poking around in Chinese commodity futures markets today because someone asked me to design a trading strategy for them (don’t ask). I didn’t even know there was such a thing as PVC futures! And Hot Rolled Coils! But one chart really struck me:
This is a chart of PTA, or Purified Terephthalic Acid. What the heck is that? PTA is an organic commodity chemical, mainly used to make polyester PET, which is in turn used to make clothing and plastic bottles. Yeah, I didn’t know that either. Here’s what else I don’t know: I don’t know why the price of PTA rose 50% in less than two months. And I don’t know whether it is used in large enough quantities to affect the end price of apparel or plastic bottles. But it’s a pretty interesting chart, and something to file away just in case we start to see something odd in apparel prices.
Let me conclude by apologizing again for the disjointed nature of this article. But I feel better for having burped some of these thoughts out there and I hope you enjoyed the burp as well.
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