This post is based on an excerpt of a recent report featured on The Felder Report PREMIUM.
April’s inflation figures came in hotter than expected and there are plenty of signs suggesting tomorrow’s report on May CPI will only add to that trend. As a result, you might think that markets may begin to price in an inflationary consensus. You would be wrong. As Nordea’s Mikael Sarwe tweeted last week:
🇺🇸 I note a growing consensus on FinTwit that sticky inflation is a consensus view. I doubt that. If it was, then the US 10-yr yield wouldn't be 1.6%. Historically, such a low yield has been in line with 1.5-1.7% core inflation, ie the bond market believes the transitory story pic.twitter.com/7nWImwSXa4
— Mikael Sarwe (@MikaelSarwe) June 1, 2021
For those unaware, core inflation is double the figure historically associated with the current level of interest rates. Essentially, the bond market is betting inflation pressures will soon recede as the Fed would like us to believe. Similarly, Michael Ashton tweeted:
US CPI swaps market still pricing transitory #inflation. Calendar year inflation extracted from curve: 2021 4.0%;2022 2.9%;then 2.4%, 2.5%, 2.5%, 2.5%, 2.4%, 2.4%, 2.5%, 2.5%, & 2031:2.5%. pic.twitter.com/HaOwW7v57i
— Michael Ashton (@inflation_guy) June 1, 2021
In addition, GMO noted last week that the stock market has also failed to reflect an inflationary consensus. In fact, the segment of the stock market most effective at protecting against inflation, energy and metals, trades at the deepest discount to the broader market in history.
'With prices rising one might expect to pay a premium for inflation protection but energy and metals companies are trading at a discount of over 70% to the S&P 500 Index, the biggest discount we have ever seen.' https://t.co/WjsxIQelBy pic.twitter.com/Yre5B6VDSE
— Jesse Felder (@jessefelder) June 2, 2021
In other words, the stock market is still pricing in disinflation. Confirming this view is the fact that, in contrast to the record discount in valuations of equity inflation protection, long-duration equities are the most overvalued ever, as noted by Richard Bernstein Advisors.
— Richard Bernstein (@RBAdvisors) June 2, 2021
So markets of all kinds are taking the Fed at their word and buying the “transitory” narrative hook, line and sinker. This sets up a potential repricing event should inflation eventually prove more sustainable than the markets have priced in.