I’ll repeat my belief that part of the US Treasury rally was due to the comments and uber dovish stance of ECB president Christine Lagarde and most of her colleagues. That rally in European bonds continues today with the German 10 yr bund yield in particular down for the 4th straight day and by 2.5 bps to -.28%, the most negative since mid April. I will say this though, the inflation figures that will be seen in Germany this year will not go over well there and we are on the road towards a Bundesbank vs ECB battle I believe. The ECB has essentially had free reign ever since Mario Draghi said ‘whatever it takes’ and no one could have ever imagined the extent to which it has led with respect to negative rates and the size of the ECB balance sheet. The only benefit however has been the financing of European governments but inflation in Germany crosses a line.
With US Treasury yields deeply negative on a real basis, I found this chart on Twitter from Chris Cole mapping real rates back to the mid 1960’s using core CPI. Quite a reflection of how far behind the 8 ball the Fed is but of course purposely. With respect to the FOMC meeting next week, we know ‘substantial progress’, whatever that means, is their guiding light but here are two sentences in the April FOMC statement that is no longer applicable and if it comes out next week, which it should, takes away another excuse in continuing on with current policy. “The path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on the economy, and risks to the economic outlook remain.” With the US at or near herd immunity when including the number of vaccinated citizens in addition to those with natural immunity, these comments are now stale. That said, I acknowledge that Covid could be with us for a while but life and medicine will power thru it and monetary policy should no longer use it as a crutch.
To the debate on transitory or not, you know where I stand but I’ll say this. I understand it will be hard to maintain the aggressive increases in used car prices that many are cherry picking as a reason for transitory, but I also believe that we are just at the beginning of broad price increases in just about everything else. And rent increases on the services side, the biggest component of CPI, you ain’t seen nothin’ yet.
We also hear from some central bankers both in the US and abroad that they have the tools to deal with inflation if they need to use them. Yes, they have the tools, that is not the question. The question is whether they have the guts to use them because of the risks those tools pose to the economy and markets. Today, ECB Governing Council member Klaas Knot said the “ECB is absolutely capable of controlling inflation.” They can’t create it but they can sure stamp it out I guess.
While the Fed, ECB and some others are afraid to change policy, the Bank of Russia raised rates by 50 bps to 5.5% and said “Inflationary pressure in the context of the completing economic recovery can lead to a more substantial and prolonged deviation of inflation upward from the target. This creates the necessity of further increases in the key rate at upcoming meetings.” Regardless of whether inflation is transitory or not, the Bank of Russia at least thinks that current policy needs to be adjusted based on what they are seeing now.
The only thing of note in Europe was the UK GDP figure for April which rose 2.3% m/o/m about as expected as the economy further reopened with the very successful vaccination campaign. It was the services side in turn that led the way. With us half way thru June, the number is not market moving.