This Time Is Not Different: Armored Wolf’s Brynjolfsson

This Time Is Not Different: Armored Wolf’s Brynjolfsson

Even though bond markets have rallied recently, many analysts have held to their year-end interest rate estimates and see this as a selling opportunity that investors can take advantage of while preparing for inflation to finally start picking up again.

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“Don’t pick pennies up in front of steam rollers,” writes Armored Wolf chief investment officer John Brynjolfsson in the hedge fund’s monthly newsletter. “Inflation is already ticking up, and it is time to short Treasuries, buy TIPS, buy Commodities, and position for Reflation.”

The Ex-PIMCO executive starts off the letter stating:

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This time is not different
Looking forward to June, my generic words of advice are:
1) Don’t pick pennies up in front of steam rollers,
2) Inflation is already ticking up, and
3) It is time to short Treasuries, buy TIPS, buy Commodities, and position
for Reflation.

Wage pressure picking up

Brynjolfsson argues that inflation is already underway because slack has been taken out of the labor market and wage pressure will start to make itself felt in roughly the next nine months. Partly this is because job growth has crossed 200,000 per month, but that bit off good news came in last month’s jobs report that was generally positive but showed that wages remained stagnant.

But he also points to data from the National Federation of Independent Businesses (NFIB) that correlates with the Employment Cost Index (ECI) showing a spike in companies’ intention to raise worker compensation (graph from Torston Slok at Deutsche Bank). If the ECI is dragged up to the 3% mark it would be the first meaningful rise in wages and salaries since the recession.

NFIB v ECI 0614 Treasuries

Wage pressure seems to contradict the reason rally in Treasuries: Brynjolfsson

This wage pressure seems to contradict the reason rally in Treasuries, but Brynjolfsson argues that it is due to a combination of temporary factors that won’t hold back the larger trends for very long. First, a combination of fears about Ukraine and ECB policy has led to a European bond rally, led by France, Spain and Italy, that has been even stronger than the US bond rally. Second, US deficits are at their lowest point in years, with the 12-month rolling average down from a high of $1.5 trillion and $856 billion last year to $499 billion today. Lower deficits “can drive yields lower both through their cyclical impact, and through the reduction in Treasury issuance they imply,” writes Brynjolfsson.

Finally, he blames short covering and technical for partly responsible for the unexpected rally, but argues that the Fed Funds rate is determined by the Taylor Rule (related to the amount of slack in the economy and the inflation target) and that it is bound to come back up.

“It’s tempting to assume ‘this time is different’, as to some extent during the first 5 years following the Lehman crisis things were different,” he writes. “Recovering from banking crisis always take a long time, which is to say this time is not different.”

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Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.
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