The 5-year Treasury yield hit 2% this morning. It’s not much, but relatively the short to middle of the curve is starting to look more interesting. As I wrote in “Patience – A Possible Win Win”, I believe “…as long as financial conditions remain stable and equity prices inflated, the Fed will most likely continue raising rates. In effect, until something in the financial markets “breaks”, the Fed’s tightening path appears to be on a set course.”
In effect, as the asset inflation fires rage in risk markets, the Fed has cover to raise rates. And who knows, they may actually be concerned they’ve lost control of their asset inflation inferno, and feel obligated to at least build some fire lines. While I expect rates to continue to rise assuming asset prices inflate further, I’m beginning to notice more signs of a significantly less friendly form of inflation – the rising prices of things and services.
As central banks openly question why inflation remains stubbornly low, I continue to notice costs and wages are rising for many of the businesses I follow. While I view inflation from a bottom-up perspective, I’m also bumping into more inflation-related headlines. Without searching, these are a few headlines I noticed this week while watching Bloomberg TV and reading the daily news.
“Canada annual inflation rises in September on gasoline, food costs”
“UK Inflation Hits 3% in September”
“Commodities Rally a Welcome Tailwind for Asia Open”
“China’s Factory Inflation Rebounded”
“New Zealand Inflation Quickens More Than Economists Forecast”
Even the Federal Reserve is beginning to take note of rising costs, or more specifically, a tightening labor market (thanks to a reader and very knowledgeable investor for forwarding).
Similar to the company-specific information I attempt to accumulate each quarter, the Fed’s Beige Book gathers and summarizes economic information by interviewing, “business contacts, economists, market experts, and other sources.” If it were me, I’d focus exclusively on the business contacts and drop the economists and “experts”, but that’s a topic for another day :). In any event, below are the Fed’s comments on labor that agree with much of the data I’ve accumulated [my emphasis].
“Labor markets were widely described as tight. Many Districts noted that employers were having difficulty finding qualified workers, particularly in construction, transportation, skilled manufacturing, and some health care and service positions. These shortages were also restraining business growth.”
“Despite widespread labor tightness, the majority of Districts reported only modest to moderate wage pressures. However, some Districts reported stronger wage pressures in certain sectors, including transportation and construction. Growing use of sign-on bonuses, overtime, and other nonwage efforts to attract and retain workers were also reported.”
Interesting, isn’t it? The CPI is up 2.2% year over year, unemployment near 4%, and the Fed’s own Beige Book is reporting tightness in the labor markets, along with shortages and the growing use of signing bonuses. Meanwhile, after an 8-9 year bull market in risk assets and an aging economic cycle, Fed policy remains in an emergency and accommodating stance (negative real short-term rates and a severely bloated balance sheet).
As I noted in a previous post, “Exactly when the current market cycle ends remains unclear, but in my opinion, the cozy relationship between short-term interest rates and equities is over. Going forward, higher stock prices will most likely lead to higher short-term rates.” And this is exactly what has happened. However, when I wrote this I was focused on asset inflation. Barring a sharp decline in asset prices, I suspect we’ll be reading more headlines related to inflation continuing to spread in the real economy. At the very least, given the widely-held belief that interest rates will stay low indefinitely, it’s something to monitor closely.
I apologize for the short post this week. As many of you can relate, I’m currently plowing through earnings season. I’ll publish my own Beige Book in a couple weeks, summarizing the operating environment and economy through the eyes of business.
Have a great weekend…and enjoy those higher interest rates!