Showing posts with label inflation. Show all posts
Showing posts with label inflation. Show all posts

Monday, November 20, 2023

Money, Bonds, and a Mea Culpa

[Executive summary/TL;DR : A huge amount of cash was dumped into the economy with the 2020 COVID relief bill, which caused the burst in inflation.  We have not yet returned to equilibrium (and lower inflation) but may by the end of 2024]

An interesting recession we are having, isn't it?

Earlier this year I stated a recession is coming, fortunately ignoring to tell you when it would happen.  More than six months later there is no recession.

The Treasury bond market is not signaling a recession either as the entire yield curve continues marching higher.  Thirty year mortgage rates continue rising, now over 7.5%, with no let up.  


The most recent GDP numbers came out and still no recession, with a real growth GDP above 2.5%


Source: Federal Reserve

So what happened?  

I think I found the reason, or perhaps, a reason.  The US economy is an incredibly complex entity and there is not just one factor which pushes it around.  I will be discussing just a few parts of it, so please keep that in mind.  Now, take yourself back to the early parts of the COVID lockdown and hysteria.  I know, a bad place to visit but sometimes finance blogging can be a scary place. In order to mitigate the lockdown, the COVID relief bill passed in early 2020 which dumped a massive amount of money into the economy, and when I mean massive, I mean unprecedented.  Just look at this graph. 

On a year over year basis M2 expanded around 17%, the largest spike in the entire data series.

To define for those who may not know,  M2 is cash you have access to immediately.

Quoting the federal reserve:

M2 is a measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers' checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds. 

Source: Federal Reserve

[Addendum added 11/20/23 -  I should have included the massive increase in the Federal Reserve's balance sheet as another possible reason for the jump in M2.  The relative importance of each (Federal Government or Federal Reserve) is not important for for the scope of this post, just that both had a factor in the spike.  Looking at the graph below one can see just how massive the Federal Reserve expanded its balance sheet, roughly triple their response to the financial crisis of 2008/09.  Currently the Federal Reserve is contracting their balance sheet and this is most likely the cause of the current reduction in M2.


Someone with more specialized knowledge regarding Federal Reserve balance sheet expansion and M2 wrote a detailed article regarding the interplay.  --End Addenum]

Now let us look at M2 as it compares to the US economy as a whole, expressed as GDP.  As the real economy grows over time a slow increase in M2 is also needed, as it is how one facilitates the transactions which make up our economy. Observe the ratio of M2 to GDP (Gross Domestic Product, the sum of goods and services consumed domestically)  Economist call the inverse of this 'monetary velocity'

Notice the massive spike in this fraction?  Again, unprecedented.




The increase in M2/GDP is even more dramatic when looking at the annual change in this fraction.


Yes, that is a greater than 7 standard deviation move.  Something that hasn't ever happened in modern US history.

So where did all that excess money go? Everywhere.  Remember the AMC and Gamestop rip higher? Money from the sky, and bored people at home created that frenzy.  Rolex prices? Yeah, that too.  

Inflation hit soon after, the highest in decades.


Source: Federal Reserve

What gives me confidence to claim the rapid rise in M2 facilitated a rapid rise in inflation? Well, The Federal Reserve looked at this 30 years ago and noticed the causation.

https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/economic_review/1992/pdf/er780502.pdf

Quoting from the above paper:

Over the three periods shown [30 years], the trend rate of growth of nominal GDP matches fairly closely the trend rate of growth of M2. 

If velocity is stable, the rate of inflation will correspond over long periods of time to the excess of the rate of growth of money over output. To illustrate, over the three decades from 1960 through 1990, the excess of the annualized rate of growth of M2 (8.1 percent) over the annualized rate of growth of real GDP (3.0 percent) was 5.1 percent, while annualized inflation (measured by the implicit GDP price deflator) was 4.9 percent.

In short, the helicopter money shower in early 2020 resulted in a lot of the inflation we are seeing today. 

Long term interest rates responded; gradually and then suddenly.


Source: Stockcharts

This is where I plead Mea Culpa to my clients.  The standard signs where there; inverted yield curve, rising continuing claims, prices appeared to have bottomed (in late 2022), etc. so I started buying long duration Treasuries.  I didn't think to look at the M2 growth, because it never changes too much.  Until 2020. Whoops. Fortunately I only started nibbling on long term treasuries in late 2022, so the pain does not compare to someone who held them as a permanent part of their portfolio.  Even now I am underweight my target bond allocation.

So what now?  Considering my irrational desire to predict the future I posit the following; we are almost through this M2 money spike, we just don't know it yet.

Before the helicopter money drop the M2/GDP ratio was at ~0.70 and as of Q32023 ratio is at 0.75. The median absolute annual change in the ratio is 0.012 so as of today we are close (0.736 vs 0.75)  to being back within the range of a 'normal' ratio.  (Source at Federal Reserve) A combination of  M2 reduction, economic growth, and inflation will most likely bring the ratio to within the normal range of variation by year end 2024. 

So, we are mostly through the money storm now? Right?  Well, maybe.  Markets and economies have a tendency to swing well past their equilibrium points as they veer from one extreme to another.  Considering just how much else is going on with the world I'm hesitant to make too many predictions with confidence. For now I've been building up my position in 90 day treasury bills instead of the long part of the bond market. When to buy more, well I don't quite know yet.

Ours is still a highly leveraged economy and the massive rise in funding costs for everyone in America as well as the inverted yield curve will eventually bite into economic growth.   Right now we have two powerful forces pulling us in opposite directions; an excessive amount of money (M2) still sloshing around the economy versus a decelerating economy due to a massive increase in funding costs.

Additionally I believe this spike in M2/ GDP may have caused multiple active allocation strategies to fail as well.  Some of these switch between equity market and Treasury bonds, but with the relentless inflation and subsequent bond market thrashing they have performed poorly.  The M2 spike we've recently experienced hasn't ever happened before, so how do you model it?   This is a facet of current finance, the impossible seems to keep happening with disturbing regularity.

additional reading:

https://www.stlouisfed.org/publications/regional-economist/2022/jul/was-paycheck-protection-program-effective

https://twitter.com/steveanastasiou/status/1651059292089499649

Friday, October 12, 2012

Inflation expectations and QE(infinity)

I have posted before regarding inflation expectations in the US treasury market and I need to give you an update, especially so considering the recent round of QE as announced by the Federal Reserve.

A refreshed chart from the Fed of the inflation expectation spread (10 year nominal yield minus 10 year TIPS yield) teases out some interesting items to consider.

10 year nominal Treasuries minus 10 year TIPS (source: Federal Reserve

Note how we have recently broke above the 2.5%  Since the GFC it has rarely breached this mark and did not stay there for long.

Now look at when previous QE's were initiated. A graph by dshort.com does the job.


While they are not to the same scale, you will notice the first round of QE was initiated during the deep dark days of the financial crisis.  The inflation expectation spread was near its low of the series and the world looked bleak.

QE2 was discussed mid 2010 and also coincided with an interim dip in the inflation spread at around 1.5%

QE(infinity) was just announced and our inflation expectation spread is already near the highs of the entire series.  

While the Fed and other market participants have their own flavor of inflation expectations they look at this series is near its highs. Before the GFC this spread didn't venture much higher and the Fed thinks they can get it higher now? The future is subject to change (of course) but unless we get some serious wage growth it appears to me the Fed is pushing up against a long term inflation expectation wall.  

As an example here's nominal Personal Consumption Expenditures.  It has been on a secular decline since the inflation days of the 80's and also notice how it recently peaked and appears to be rolling over again (ahem)

Nominal PCE - Source Federal Reserve


For some additional context here's the 10 year nominal and TIPS yield since 2004. Notice how now 10 year TIPS are now going for a negative real yield.



Disclosure: Considering selling/shortening duration on some TIPS positions

Thursday, November 17, 2011

Inflation expectations in the bond market

Here's an update on inflation expectations as expressed by the bond market.   As the nominal 10 year yield continues to drop it has pushed the TIPS real yield to nearly zero.  Some investors may grouse at the option of buying a security that guarantees a zero real return for the next 10 years and I agree with their sentiments. 


As to why this situation exists I would suggest it is a result of the Fed's desire to reflate the economy by numerous unconventional means (zero short rates, all the various flavors of QE)  


The spread between nominal and real yields has remains remarkably stable near the 2% mark with some noise on either side.   If we have another financial crisis, this time in Europe, I wonder if we'll see another drop in the implied breakeven rate....

Tuesday, August 16, 2011

Long term treasury rates in a bubble? Maybe not?

Talk of a bubble in long term treasury rates has been careening around the financial markets for a while now and considering the rate on the 10 year T note is approximately 2.22% right now I went looking for some perspective.

10 year versus nominal GDP:
Econompic has a great series relating nominal GDP growth versus the 10 year and the long term patterns are impressive. 
Note how during the rise in nominal gdp growth rates from the 60's to the 80's interest rates were below nominal gdp and this pattern flipped as nominal gdp growth rates declined.

90 day tbill rates versus 10 year:
Rarely does the spread between the 90 day tbill and 10 year rates go beyond 4% and with short rates at zero this puts a cap on interest rates further out the curve.  With 10 year rates at 2.22 this does provide some upside to the range of interest rates, but those recently calling for 10 year rates higher than 4% were calling for something truly exceptional.

Until we see nominal GDP growth really perk up and/or the Fed start raising interest rates I find the possibility of the 10 year going above 4% unlikely. 

Disclosure: I own long term treasuries in personal and client accounts.


Thursday, April 14, 2011

Inflation expectations in the bond market

Here's an update on inflation expectations as expressed by the bond market.   While much is being said right now about inflation expectations becoming unglued the 10 year [Treasury - TIP] difference is not showing anything exceptional yet.   As you can see from the chart inflation expectations (as expressed by nominal yields - 'real' TIPS yields) are getting back to their 'normal' range of around 2.5 percent.

10 year TIP yields are near the low end of the range but some of that is due to nominal yields slowly dropping over time, pushing the TIPS yields down so the difference remains relatively constant.  With QE2 slated to end and oil prices (as well as other base commodities) rising it will be interesting to see if the implied breakeven inflation rate rises above long term resistance of ~2.6 percent.

Thursday, December 9, 2010

Inflation update

With the recent rise in interest rates I thought revisiting inflation rates would be helpful.

3 data series on this graph [click to enlarge]:
Blue for total Consumer Price Index (CPI) aka 'inflation'
Red for inflation minus (food and energy)
Green for housing subset

Notice how overall inflation tends to peak at the onset of a recession.
Headline inflation is still very low overall at near 1%
Housing inflation is still negative.
Inflation less food and energy is at a low for this timeline and is trending down.  Yes, we all need to eat and consume energy but both of those items are extremely volatile and stripping them out of the data series can provide additional useful information.

China comes to mind when people speak about energy and food inflation and like almost every other basic commodity the Middle Kingdom overshadows other negative factors such as Europe's continuing austerity drive and our own tepid domestic growth.  To me it appears whichever way China goes the energy, food, metals, etc. complex will follow.

Tuesday, October 12, 2010

Inflation expectations

The recent rumors of an imminent second round of quantitative easing (QE 2.0) by the US Federal Reserve has sent ripples throughout the entire financial market.  One series I occasionally check in on is the implied breakeven inflation rate by looking at nominal versus inflation protected rates in the treasury market.    The threat of QE 2.0 can be seen here as well.


10 year inflation protected rates (TIPS) have fallen to levels not seen for this entire data series.  In other words people are bidding up the value of inflation protection.    However in the context of comparing TIPS rates to nominal the spread is trending downwards but is not out of the ordinary. 

Interesting. 
Of course the Fed threatening to buy up outstanding T bonds (instead of just buying more at auction) also creates a supply demand issue but this trending divergence bears watching.

Wednesday, July 21, 2010

Inflation watch -- Headline inflation rolling over.

Inflation data was released recently.  The headline rate of inflation continues to roll downwards towards zero as the chart shows.  (Source: Federal Reserve)  With oil prices no longer going higher it is likely the headline inflation rate will continue declining.  'Core' inflation (red line)  has been stuck at 1% for the last few months but the longer term trend looks downwards to me as well.  The housing component is stuck in negative territory.

Overall the trend is down for all the sub components of inflation. 

Wednesday, June 30, 2010

No one is talking much about deflation . . . yet.

US Treasury rates have dropped recently and it appears to me they may continue declining.   How low can they go?  I have no idea but I thought it would be interesting to look at when 'deflation' was a popular search term on Google.  Click on the screen capture at the right and you'll see searches spiked around the same time long term US Treasury bond yields dropped very quickly.

I wonder if we'll get another spike in search traffic for deflation if bond yields fall again . . .

Thursday, June 24, 2010

Hugh Hendry takes on . . . . Everyone

Mr. Hugh Hendry is always fun to watch and even more so in this interview:





He discusses the euro, china, George Soros and the 'axis of financial evil'. 

ht: Zerohedge

Thursday, May 27, 2010

Money Money + Money -- Money supply update

Money supply figures supplied by the Federal Reserve (as of 2010-05-27) continue to decline.  The data shown is the sum of M2 and Institutional Money Market Funds (the only subset of M3 still reported)  As you can see money supply tends to drop during / after recessions and recovers as economic activity increases.  We are in uncharted territory as this data set has not shown negative growth for the entire data series.

Considering the growth rate is decidedly negative and shows no inclination of slowing down this is worrisome for future economic growth. 

Wednesday, May 12, 2010

Austerity in Europe, it's so fashionable right now!

As I mentioned recently the austerity would be coming with the bailout packages.  It didn't take even a week and the cutbacks have already started.

Today - Telegraph
Premier Jose Luis Zapatero told a stunned nation that public sector pay will be reduced by 5pc this year and frozen in 2011. "We must make an extraordinary effort," he said.

Pension rises will be shelved. The country’s €2,500 baby bonus will be cancelled. Aid to the regions will be slashed and infrastructure projects will be put on ice. Mr Zapatero’s own monthly pay will fall 15pc to €6,515.


more from the Telegraph today in another article
Jose Luis Rodriguez Zapatero, the prime minister, on Wednesday outlined a series of measures that will include a suspension in automatic increases to retirement pensions, a drop in overseas aid and a reduction in government investment.
He said 13,000 civil service jobs would be cut in 2010, with public sector wages frozen in 2011.


Spanish citizens will not be too happy about this and the austerity packages will tilt yet another country towards recession.

Monday, May 10, 2010

We're from the IMF and we are here to help you.

Before the PIIGS (Portugal, Italy, Ireland, Greece, Spain) of Europe breathe a deep sigh of relief as their funding problems are 'fixed' there's a few items to mention:

Assuming the money arrives you still have to deal with the IMF which has a usual gameplan of:

  • Devalue the currency
  • Raise taxes
  • Cut government spending
Item 1 is out the door as countries use the Euro
Raising taxes and cutting government spending is not a mix that encourages GDP growth.  Consider that when making your investments.   Don't forget that during this period of IMF induced austerity debt / GDP levels will continue to rise.  This is the mother of all 'kicking the cans down the road'.

The wad of money (nearly a $US Trillion!) will be used to allow countries to roll their debts, not stimulus.  The French banks are breathing a deep sigh of relief right now.  Everyone else should rethink what this all means.

Here's a video with my favorite hedge fund agitator explaining the situation.  This interview occured before the announcement but it still holds true.



(ht Zerohedge)

Wednesday, April 21, 2010

Money Money + Money --> Money supply update


Money supply figures continue their decline on an abolute and/or relative basis depending upon how you measure it.  M2 + Institutional Money Market Funds (the only series left from M3) continues declining on a year over year basis, M2 on its own continues to decelerate.  Once the MBS purchases by the Fed finally settle I think the first derivative will continue to decline on both series.

Thursday, April 15, 2010

Inflation update - - The slow slide continues

Inflation numbers were just released and continue to show the slow slide downwards in core CPI numbers.    I modified the chart to highlight core CPI.  As you can see it is still trending downwards along with the housing subcomponent. 

Core CPI touched the 1% yoy level in 2004.  Considering the direction of core CPI we may penetrate that lower level soon(tm)

Housing CPI is still deflating and I don't see that changing anytime soon.

While headline CPI is still higher than core I don't foresee it rising too much more without putting a serious dent in the economy.  $150 oil helped knock the economy over last time and if oil prices continue to rise it will start to crimp the economy again.

Tuesday, April 13, 2010

A veteran's view on short term interest rates pinned at zero

While I disagree with Mr. Koo's prescription for getting out of Japan's mess (more stimulus) his battlefield view of what happened and why Japan is going on 20+ years of malaise should not be discounted:



(ht: Pragmatic Captialist)

Thursday, March 18, 2010

Inflation expectations and the Treasury market

Here's your TIP / Treasury market update.  Nothing extraordinary has happened in the Treasury / TIP market in the last few months.  As mentioned in my last entry the easy money has been made and now it is a lot harder (Tips v. nominals)

One item of note is the real TIPS yield is still relatively low as compared to the history of this data series with the last entry being a 1.42% real yield.  Not very exciting, eh?  The 10 year breakeven inflation rate is effectively where it was two years ago before the Financial panic hit (2.27%) 

Monday, March 1, 2010

Inflation update

Inflation numbers came out a little while ago and it continues to show a decline in overall inflation rates excepting the volatile food and energy segment.   All the data shown is year over year, non seasonally adjusted.  
Core CPI inflation (line in Red) continues a slow decline.  CPI Housing (line in Green) remains stuck at below zero and will most likely remain there for a while.  The Wall Street Journal has some more detail on the data.

For all of you looking for inflation, where is it?  Money supply is falling (I'll post about that soon(tm) ), credit is contracting, the dollar is getting stronger, and inflation is falling.  Longer term I concede it is possible but over the next 12 months I don't see it.

Friday, February 26, 2010

Hugh Hendry on China's chronic overcapacity and what it means.

Hugh Hendry once again nails it (in my opinion) as to what China's conversion into the workshop of the world really means.

This appetite for cheap Chinese exports, which had at one point seemed insatiable, means that we in the West have come to owe our largest Asian trading partner quite a hefty sum of money. China has become the world's biggest creditor, after amassing nearly $2.3 trillion of foreign exchange claims on us. However, the spectre of a creditor nation running persistent trade surpluses has ominous historical portents. It has happened only twice before, with the US economy in the Twenties and with the Japanese economy in the Eighties.
Read the entire article, it is not long.

Monday, January 25, 2010

Inflation expectations in the Treasury market


Relative to nominal treasuries, TIPS were a raging buy at the beginning of 2009 (I bought some then for income clients) Since then the ratio has begun to close in on its apparant long term average around 2.50 (eyeball average)

Note how steady the implied breakeven rate has been since ~2003 excepting the crisis of late 2008 - early 2009.   With the current great debate raging between the inflationists and deflationists it is interesting to now how much this indicator has not moved, and is actually returning to a long run average.