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Inflation Indicators Are Sending Us Mixed Signals About The Future

inflation sending mixed signals
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EDITOR'S NOTE: Yahoo! Finance sums up the economic mood of the country perfectly in the opening line here saying, “Investors are more worried about inflation than the Fed seems to be.” While the U.S.’s central bank is holding on to a diminishing handful of economic indicators that aren’t signaling long-term inflation, investors with real money in the markets that would be crushed by an interest rate hike are worried. Whenever the Fed raises rates — which seems like a certainty now — the stock market, which has been propped up by the Fed for a long time now, will dip dramatically or even worse. That’s why the Big Banks and institutional investors are starting to prepare for this eventuality, even with the "mixed signals" out there now. 

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Tuesday, November 9, 2021

Investors are more worried about inflation than the Fed seems to be.

Amid the market’s debate over whether inflation will prove transitory or permanent, closely tracked indicators, such as bond yields, are sending us mixed signals about the future.

That in part is because the real economy is also fighting through competing impulses of its own. The supply chain crisis, and the upward pressure it’s putting on soaring inflation remain the two biggest themes of 2021.

COVID-19 of course, remains a force multiplier behind everything, with the pandemic doing little to curb insatiable demand. October’s jobs data, which blew the doors off the figurative barn and helped propel stocks to new record highs, did little to resolve the debate. And yields — which themselves should be true north of inflation and Federal Reserve policy expectations — are also sending mixed signals.

Still, evidence is growing that investors are getting really restive about the central bank’s ability to contain inflation. As Yahoo Finance’s Brian Cheung wrote on Monday, a “sharp rise in real interest rates” and “inflation surge” were the second and third most cited shocks cited by a New York Fed survey.

In the wake of the Fed’s decision to begin pulling back on its stimulus, the Morning Brief discussed the way in which interest rates on government debt should be a barometer of the Fed’s next moves (both its plans to taper bond purchases and upcoming rate hikes).

“Should” is the operative word here, given the topsy-turvy way in which the pandemic, the massive government response to mitigate its effects, and the lingering impact of bygone crises, is making a muddle of investors' ability to read the financial tea leaves. Bond yields have also been whippy, telegraphing the market’s confusion about where things are headed.

But among Wall Street watchers, a clear picture is emerging about whether they think the Fed will be able to sit tight on rates — and it’s less than encouraging.

Sam Stovall, chief investment strategist at CFRA Research, suggested that trying to compare the Fed’s current plans to curtail stimulus to that of 2013-14 (the last time the central bank tried to unwind crisis-era policy) will “prove challenging, at best, since fundamentals are very different from that of eight years ago.”

For a bunch of reasons these days, the past isn’t necessarily prologue, but it can provide useful markers for where things are headed. In a research note, Stovall pointed out that at the time, headline consumer prices were below 2% (they’re now above 5%), and the benchmark 10-year yield was nearly double its current levels. Meanwhile, gold was trading at a substantial discount.

But as the Morning Brief pointed out last week, hotter-than-expected inflation is going to provide an acid test for the Fed’s willingness to delay liftoff of rates. And with jobs still being created at a healthy pace — and wages still on the rise — this week’s consumer data will amplify the debate.

According to Stovall, “the Fed started raising short-term rates in December 2015, or nearly 14 months after the end of the tapering period. This time around, we think the Fed could start hiking six months later, as we see the first quarter-point rate hike coming in Q4 2022 and proceeding into 2023 at a measured pace.”

He’s not the only one who sees the Fed moving sooner rather than later. Over the weekend, analysts at Goldman Sachs warned that the imbalance between supply and demand will drag on longer than expected, “and the inflation overshoot will likely get worse before it gets better.”

The bank warned that spiking goods inflation has become “the biggest surprise of 2021,” and prompted analysts to yank rate hikes forward by an entire year, to July 2022.

“Subsequently, we expect a funds rate hike every six months, a relatively gradual pace that assumes a normalization in goods prices and in overall inflation (albeit later and more partial than we previously thought),” Goldman wrote.

“Beyond the next few years, we expect nominal policy rates across most [developed] economies to rise well beyond the rock-bottom levels now priced in the bond market,” Goldman Sachs wrote.

Which brings us back to the point I made last week — watch bond yields, which aren’t likely to remain below 2% for much longer, given that price pressures will continue to assert themselves.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

Originally posted on Yahoo Finance.

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