We continue to be on the lookout for interesting research on the inflation outlook and how this will play put out in markets. Today we highlight inflation research specialists, Economic Perspectives, who’s analysis shows that inflationary pressures are building most strongly in advanced economies, as shown by producer prices and labour market cost measures. In fact, labour shortages are spilling over into wage bill acceleration, they show. Vacancy ratios in the US, the UK and the euro area are now flashing bright red. Norway is the latest advanced economy where inflation has surprised to the upside, today. Still, Commerzbank argue that this won’t result in a change to the Norges Bank’s defined rate path. Meanwhile, following last week’s steepening of the US curve, we highlight some thoughts from Julian Brigden of MI2 Partners. His view is that financial conditions are far too loose still, partly because the Fed fears the effect of an inverted curve. The problem, argues Brigden, is that unless it is quickly countered by a significant acceleration in the current path of rate hikes (unlikely), it could easily leave the Fed behind the curve and battling a “bear steepener”, as yields at the long end spike. Last week was that shot across the bows. Switching out of inflation, and turning to the Far East, Nomura are bullish on their equity market and USDJPY, while Gavekal highlight the nuances of local government development projects, including Xi’s pet project, the so-called Northern Powerhouse.
Substantive's Top Themes - Best of the Broker Notes
China
Infrastructure
Gavekal
1. China; Building The Northern Powerhouse
The endless supply of capital to China's local government projects is a thing of the past. After a decade of splurging on infrastructure projects, China’s local governments are now having to cut back. But Beijing has continued to pour money into centrally supported initiatives, particularly Xi Jinping’s pet project for developing the region surrounding Beijing. In this piece, Gavekal's Tom Miller reports on how this northern mega project is progressing. Click below to request this as a sample from Gavekal directly.
Inflation
Norges Bank
Norway
Commerzbank
2. And the Latest Upside Inflation Surprise Comes from.....Oslo
Don't get carried away with buying the NOK today after Norway's latest inflation data came in above forecast today. This does not mean that Norges Bank will suddenly accelerate its rate hike cycle, say Commerzbank in a note today. In September, when it hiked interest rates, Norges Bank made it clear that it will stick to a very gradual rate hike cycle. It will also tolerate inflation temporarily overshooting its inflation target. Of course its tolerance is not unlimited, say Commerzbank, but the central bank expects inflation to slowly ease off a peak of 3% in the autumn anyway. According to Norges Bank’s forecasts the core rate will only peak in the second half of next year before weakening again. So, Commerzbank concludes that as long as the path of these projections does not change, Norges Bank will not change its view either. That means that over the coming months price data well above the inflation target should not irritate markets. A gradual rate hike cycle suggests that NOK will appreciate against the euro over the coming quarters, but short term the oil price remains the main driver in NOK, they say. Commerzbank clients can read this note and other notes from today including the how there seems to be a growing period of disenchantment with the euro as among other things, Macron is losing his shine.
Equities
FX
Japan
Nomura
3. Declining Japanese Policy Uncertainty; Another Buy Signal for Equities?
Post the chronic summer heat waves in Japan (We thought we had it bad in UK/Europe), there have been some major events that have come and gone -without major incident, it must be said - and which have now cleared the path of uncertainty for investors, writes Yujiro Goto from Nomura's FX strategy team. Neither the BOJ meeting, the LDP leadership election or the US-Japan summit meeting provided major negative surprises for markets. The question now is, what does that mean for Japanese asset prices? Goto looks at historical patterns of policy certainty/uncertainty as a guide, and finds another tailwind for local equities and USDJPY. Nomura clients can read on the via research portal here, Other interested readers, click below.
Curve steepeners
Rates
MI2 Partners
4. Financial Conditions Too Easy; Fed Left Battling a Bear Steepening
In light of recent moves in long-term yields, we wanted to highlight this prescient piece by Julian Brigden from MI2 Partners published last month where he argued that the spread between 2yr and 10yr Treasuries was exaggerating the level of monetary tightness. That’s because when bond markets are this manipulated it is important to look beyond the curve to the level of underlying rates. At the same time, stoked by the Administration’s fiscal stimulus, inflationary pressures are continuing to build both in the form of PCE and CPI, but most importantly in wages which, after the best part of 3 years of treading water, are finally accelerating. The result is that Brigden expects to see 3.25% Average Hourly Earnings by spring next year. All this leads to a scenario which, unless it is quickly countered by a significant acceleration in the current path of rate hikes (unlikely), could easily leave the Fed behind the curve and battling a “bear steepener”, as yields at the long end spike, as we saw last week. MI2’s piece also comes with a trade recommendation, where Brigden recommends swaptions as the preferred instrument instead of cash. Even considering this week’s moves, Brigden told us last week that this is still a good entry point because IF we have really broken key levels in the long-end, then it’s a multi year move to 4.5% in the 30-year part of the curve.
Global inflation
Economic Perspectives
5. High Vacancy Ratios are Red Light for Labour Market Inflation
Inflation is a multi-faceted phenomenon with roots in demographics, socio-economic tensions and political contexts as well as monetary conditions, according to the Economic Perspectives Global Inflation Update for September. Inflationary pressures are building most strongly in advanced economies, as shown by producer prices and labour market cost measures, the research shows. In fact, labour shortages are spilling over into wage bill acceleration, the research argues. Vacancy ratios in the US, the UK and the euro area are now flashing bright red. G7 GDP weighted unit labour cost annual growth is moving upwards, as is G7 wage bill annual growth, charts from Economic Perspectives indicate.
