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Bonds 1, Stocks 0. I already mentioned last week that bonds and stocks are beginning to de-correlate while both went up. So for anyone that took advantage of the warning, the picture is even more drastic this week!
Long-term bonds are up 2% and stocks are down about the same amount. The irony here is that this negative correlation is the “classical” reaction function to bad news. People reallocate from stocks into bonds, causing bond prices to go up and yields to drop. It just hasn’t been happening in the last few months because the Fed was hiking causing a liquidity squeeze, and deflating all asset values. That dynamic is over. So what’s next?
Most notably, PCR test results are no longer needed to go into supermarkets, office buildings, public venues, or mass transit. That makes life much easier, but tests are still required for other establishments such as schools and hospitals.
Other changes are more organizational. These include making lockdowns a lot more surgical instead of entire city blocks, as well as building more hospitals in anticipation of having to tolerate higher infection rates due to looser restrictions.
These changes could not have come sooner. Part of the change was driven by a letter from Terry Gou, the founder of Foxconn, urging senior Chinese leaders to ease COVID restrictions.
It’s too early to say whether these measures will boost growth but needless to say it’s a big step in the right direction.
Most economic indicators continued last week’s story of slightly faster than anticipated cooling of inflation-related measures. This was one of them. Labor costs have been stubbornly slow to cool as evidenced by last week’s NFP numbers.
So it came in as a relief this week when it surprised to the downside. Not all was fine and dandy however as equity markets continued to struggle amid challenges from sectors such as housing and autos.
Most notably, rumors swirled of a potential bankruptcy by Carvana, an online car marketplace and high-flier of the COVID debt-fueled equity boom.
We mentioned a few weeks ago that crude has been dropping about $5 a week, and the pace has only accelerated in the last 5 days. There’s a strong relationship between crude and gas prices at the pump, and they have fallen below last year’s average.
As always, this is a tremendously volatile asset class and any complication in the Ukraine-Russia conflict could meaningfully change prices. But…winter is coming. It’s likely the next few months will enter a much slower pace of development for either side and potentially keep gas prices stable which will be a huge help for households.
This is probably the only component that didn’t fit the story this week. Bonds retraced as a result of the news. How big of a deal is it? Not a lot. What will be a big deal though is what comes next week.
It seems at least 70-80% of the economic indicators support a slightly faster than anticipated cooling. The only challenge has been the labor supply. Amongst the other interesting one-offs, this week was an averted railroad worker strike that sought to boost union wages by around 25% over 5 years.
Also given the extremely tight supply dynamics, even a recession would only cause labor to loosen from all-time tights to average. On a super long-term view, none of these dynamics seems to be easing given birth rates and immigration patterns.
So while I'm cautiously optimistic the Fed will be able to keep the current bout of inflation under wraps, I’m not so positive that we’ll get back to our post-2008 lows.
Regardless, next week is a big one. We’ll get CPI and FOMC. But on top of that, the Fed will publish its Summary of Economic Projections (SEP) giving us a glimpse of what their projections are for the fed funds rate. Stay tuned!