Concerns over Expectation translated into Reality
Last week, the Philadelphia Fed index surprised on the upside showing the highest prices paid component since 1980, which clearly contributed to the broader reflationary theme. However, prices paid (54.4 to 75.9) increased far more than prices received(15 to 31.8), and that brings to mind the risk of profit compression as we move out of the pandemic. The underlying issue will be gauging how much pricing power producers actually have in pushing through costs to the end user.
On the side of risk assets, there is a rotation from essentially the pandemic winners to the pandemic losers, i.e., out of the tech sector and into everything else, and this is very consistent with the broader theme of reopening optimism. The faster path towards inoculation certainly has contributed to an already ambitious outlook that risks bringing forward all of the upside that the market was expecting to occur in the second half of this year into the first half, while the point is how quickly we move on past the stimulus impact as well as what the actual economic data tells us as we get into the third and fourth quarters of this year. Much of growth 0f 2021 will ultimately be concentrated in the first quarter because of the stimulus efforts. So once we work through the upside from the stimulus checks and the real economy transitions into the new normal, there will be a bit of a reckoning.
We saw ten-year break evens reach 2.34 while three month annualized core CPI is running at just 0.7%, which indicates at some point there’s going to have to be a rationalization of the divergence between expectations and the realized data. Now that could certainly come in the form of the data itself picking up to match expectations, but may be more likely is that some of these expectations need to be moderated at least on the margin. The translation of inflation expectation into sustainable, non-transitory upward pressure on consumer prices that is going be this year’s biggest question and uncertainty.
We’re still early enough in this year’s data cycle that disappointments on the core inflation front won’t derail broader expectations. Inflation expectations won’t really be vulnerable to a rethink until we’re into the summer months; i.e., through the first stages of the reopening, vaccination levels continue to increase, and the real economy is somewhat back on track.
Overseas Buying
As we’ve seen in the month data, over the last four weeks Japanese investors have sold a net of $36 billion in overseas notes and bonds. Now, this is a typical process of profit repatriation. This isn’t new. It’s historically contributed to bear seasonals in the beginning of the year.
Over the course of April it will be prudent to watch the primary offerings of Treasuries, particularly fives and sevens. As we look at fives and sevens, any potential weakness could presumably be attributed to the Japanese fiscal year end with the assumption that that is poised to reverse in the second quarter.
All About Macros 