Albert Edwards has peered into the future, and he sees the whites of inflation’s eyes. How can the head of the Societe Generale’s global strategy “team” tell? The very individualist Edwards notices that Americans are set to take more holidays than at any point in history. He then correlates union / worker power with inflation as he sees the overheated future ahead as wages rise. In other words, Janet Yellen is walking into the sunset with the hero’s cape on just as a constrained Fed toolbox in 2018 might be tested as never before.
Average Americans with money in their pockets crowds tourist destinations
History is at a very unusual point, one that Edwards has keenly documented over the years. He has recognized the importance of non-economic demand that artificial stimulus represents and connects dots with historically low – and never before witnessed, negative – interest rates.
It can be documented this conscious decision to make the interest rate market flaccid has also correlated with historic lows in volatility. Likewise, certain market correlations and cycle timing have become challenging for active managers to comprehend.
These placid and oddly tranquil times are when more Americans plan on taking a vacation and enjoying life, which is also a societal benchmark, a trade execution trigger of sorts.
“No wonder it was so difficult to book hotels in Yosemite National Park and Lake Tahoe next May!” Edwards quips as he marks an interesting correlation. When average Americans are enjoying life – spending money that crowds top vacation spots or earning high wages – these periods of time are inflationary.
It is here that Edwards sees the future, and it has inflation in it. The pendulum always swings back and forth.
“I know US consumer confidence has been booming on the back of a surging equity market, but cheap money has also prompted the consumer to book holidays galore.”
Yes, average Americans might actually be enjoying life. But it won’t last. “When the bubble bursts, households will be mighty pissed that it’s not just their wealth that evaporates in front of their eyes but their ability to vacation like never before.”
The market dog is about to bite back
Free markets are nothing more than measures of economic supply and demand. There is a reason that market manipulation – ala the Hunt Brothers cornering the silver market, the second worst disaster in the derivatives industry history – is against the law. Markets are designed to send economic messages and ultimately balance supply and demand. Putting an unduly heavy hand on free markets can work for a short period, creating abnormal tranquility. But the reality of life is that the pendulum has always swung back.
Edwards has a more technical outlook on this concept:
The supposed flattening of the Phillips Curve (which effectively means that low rates of unemployment result in more moderate wage inflation) is probably the most important economic event boosting asset prices at the moment, because it is prompting a much more relaxed pace of central bank interest rate increases than would usually be the case.
The level of unemployment and inflation, which the Phillips Curve measures, has always held true. Eventually when demand catches up with supply the market changes. Corollary market relationships that have fundamental economic roots typically revert back to the mean.
Edwards looks to his colleague Kit Juckes for insight. She said:
What matters from here, of course, is the outlook for inflation. Clients tell me that strategists fall into one of two camps – those who believe faster wage growth and the revival of the Phillips Curve is just around the corner, and those who have completely given up: they see no reason to look for higher inflation and they therefore have no reason to expect the range in bond yields to break. The ranks of the latter camp have grown dangerously large and this is now the consensus view. Maybe that’s why the dollar is making such heavy weather of bouncing.
From Edwards standpoint throughout this workers wage growth has been "the dog that failed to bark," he wrote. "The risk is that the market is hugely vulnerable if it hears a distant bark, let alone feels its bite."
The barking dog of a market is upon us, Edwards thinks. If he is correct, now is the perfect time for Janet Yellen to take a hero’s walk into the sunset as the most difficult surgery in Fed history is handed off to a man named Jerome.