The last thing a central bank wants to see is inflation becoming headline news. In their ideal world, CPI is a small, one-paragraph item on page 5 of the business section (or about the 61st story on the newsfeed), providing a few terse details on the latest one-tick move and read only by some lonely souls who don’t get outdoors much and perhaps study the economy for a living. Suffice it to say that 2022 is not turning out to be their ideal world—to wit, the March CPI result was the top news story on all the Canadian national newscasts and number one on the newsfeed this past Wednesday, crowding out the war in Ukraine, the pandemic, and a homegrown Jeopardy star. Not ideal at all.
Almost a year ago, we warned about the coming earthquake for inflation, and how central banks and the consensus were far underestimating the risks for a sustained bout of uncomfortably high price pressures. But even we have been blown away by how far inflation has risen in that year. Remarkably, Canada’s outsized 6.7%
y/y headline inflation rate is below the median pace in the industrialized world, with the U.S. at 8.5%, the Euro Area at 7.4%, Britain at 7.0%, and New Zealand at 6.9%. A wide range of developing economies are even higher. Even Japan is reporting 1.2% headline inflation, the highest in more than three years (hey, you have to walk before you run). Canadian producer prices also surged 4% m/m in March (and a towering 18.4% y/y), the largest monthly advance in the 66-year history of the series—that’s a lot of history.
The issue for central banks is that the blazing headline increases, and the garish publicity surrounding them, run the very real risk of destabilizing inflation expectations. On-the-ground intel finds that conversations among relatives and friends (non-economists; yes, we have a few), have suddenly morphed from swapping stories about how much house X down the street sold for (“Can you believe it? Ridiculous!”) to how much product Y has risen since the last purchase (“Can you believe it? Outrageous!”). Not surprisingly, consumer inflation expectations are gradually climbing. And, note that the implied 10-year breakeven inflation rate in Treasuries hit 3% this week, while the 5-year forward rate climbed to an eight-year high of almost 2.7%.
Accordingly, the messaging from central banks is continuing to ratchet higher. Chair Powell said on Thursday that the Fed will move “expeditiously” to get rates back to neutral (or about 200 bps north of where we stand today). He all but sealed the deal on a 50 bp step on May 4, albeit dampening speculation of a 75 bp hike—as mooted by James Bullard earlier in the week—at least for now. Curiously, BoC Governor Macklem did nothing to quash chatter of a possible 75 bp hike, by suggesting “nothing is off the table” on the same day. A fair question to pose that if truly dramatic action is required, why stop at 75? Why not 100? And, why wait for a meeting? After all, when rates were being slashed during the opening days of the pandemic, no one was waiting for meetings, and the Fed wasn’t constrained by 50 bp steps. We lean to the view that nothing so dramatic is in the offing—yet—and still look for a series of 50 bp hikes by both. Having said that, the next round of inflation readings in the coming month is critical, to gauge whether the March spike in commodities seeped into even more spaces in April.
Markets are still taking on board the reality of just how much work the central banks still need to do, and how fast they need to do it. It seems like every time we are nearing peak hawkishness, an even uglier inflation report lands on the doorstep, and the hill gets higher. Bond yields pushed notably northward again this week, in a distinctly bearish flattening fashion. The biggest mover was Canadian short rates, on the combo of the CPI and 75 bp chatter, lifting 2-year yields roughly 30 bps to 2.7%. While the closely watched 2s10s curve remains positive, it narrowed heavily this week, to +18-20 bps in both the U.S. and Canada from 34-37 bps just a week ago.
Long-term yields managed to back off a bit late in the week, in part due to some softening in oil prices (WTI dipped back to $102). Still, this week’s sell-off saw a variety of milestones hit in bond markets, and not just in North America. Here is but a small sampling of some of the most notable:
The 10-year real Treasury yield briefly turned positive for the first time since the early days of the pandemic, and after spending most of the past two years closer to -1%.
Both 5- and 7-year Treasury yields touched 3% this week, or just shy of decade-highs for both.
Canadian 5-year GoCs poked above 2.85%, north of the prior cycle’s peak and the highest in more than 10 years. These important yields are now up 190 bps in a year, the fastest y/y rise since 1995.
German 10-year yields, after just turning positive in February, are now nearing 1%.
Japanese 10-year yields, after being pinned near zero for years, are straining the BoJ’s 0.25% target.
Equities are glancing nervously over their shoulder at bonds’ behaviour. The TSX fell 2% on the week, but not before testing an intraday high earlier on Wednesday. And, thanks to its hearty resource sectors, the index is still clinging to a modest gain for the year. The S&P 500 eased 1.5%, and remains down 9% this year—and below both the 50- and 200-day MA. Yet it’s still above its pre-invasion level. But it’s the high-multiple Nasdaq that is suffering the most from the grinding rise in yields, as well as a few specific issues (e.g., Netflix). The index dropped another 2.7% this week and currently sits 19% below its record high, set just five months ago.
A market that is beginning to show some real interest in the rapidly evolving central bank outlook is foreign exchange. The U.S. dollar has climbed all the way back to pre-pandemic levels against the advanced currencies, and is up 10% from the lows hit just last May. The yen has especially skidded, falling 16% y/y to a 20-year ebb. European currencies have been steadily leaking lower, with the U.K. pound dropping almost 2% in the past week alone, joining its euro cousin. (Oddly, the Russian rouble, while down a bit versus the U.S. dollar in the past year, has actually gained on the crosses, and is about flat since the invasion. Amazing what severe capital controls and a 17% interest rate can accomplish.) Even the Canadian dollar has retreated to a one-month low below 79 cents (or $1.271/US$), despite the hawkish BoC talk. Apparently, even the hottest inflation in 30 years can’t buy you more than a few days of currency gains.
It’s tough to know where to begin looking when an inflation reading so badly overshoots expectations, as did the whopping 1.4% monthly rise in Canada’s CPI. In the past 70 years—aka a pretty long time—there have only been five months with larger increases, and one of those was the introduction of the GST (in Jan/91). While soaring pump prices were the lead factor, even ex-gasoline was up a massive 1.0%. Our pick for #1 star last month was furniture prices, which rose 8.2% in a single month, the highest in records dating back to 1949. Prior to the pandemic, the previously fastest monthly rise was 3.3%.
In some ways, furniture captures all the aspects of the pandemic economy—a raging housing market, soaring demand for goods, rising tariffs and a snarled supply chain. And, as a result, furniture prices have jumped more than 20% since February 2020, after essentially lying flat for 25 years, like a giant beast awoken from a lengthy slumber. Let’s hope this is not emblematic of inflation as a whole.