by Bryan Perry

July 7, 2021

One notable thing about this market is that it can’t seem to make up its mind about whether inflation is going to take off or has already peaked. If you listen to the Fed, the second quarter will mark the highest rate for inflation we’ll see. It will cool off in the months ahead. But if you listen to some other notable pundits – like major fund managers Ray Dalio and Mohamed El-Erian, or former Treasury Secretary Lawrence Summers – then inflation is growing, and the Fed is an ostrich with its head buried in the sand.

It took some time, but the Fed has finally acknowledged rising inflationary forces, since they raised their 2021 forecast to 3.4% from 2.4% in May. That’s no small adjustment, but the market has currently bought into the “transitory inflation” narrative – until the key June inflation data rolls in next week (July 13-14).

Even as the stock market has overcome its inflationary fears by setting new records, there are concerns in America’s C-Suites about input costs, wage pressures, and Fed policies. The Fed’s favorite price gauge, the personal consumption expenditures price index, excluding the volatile food and energy sectors, rose 3.4% in May  from a year ago, the highest level since 1992 and well above the central bank’s 2% target.

Personal Consumption Expenditures Price Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

U.S.-based chief financial officers see inflation as the biggest external risk factor their businesses face, according to last quarter’s CNBC Global CFO Council survey, surpassing Covid-19, cybersecurity, and consumer demand. This leap in inflation concerns was huge, as virtually no CFO cited it in the Q1 survey.

Mohamed El-Erian, chief economic advisor at Allianz, told CNBC last week, “If you were actually to look at the numbers on inflation, you would start having serious doubts in your mind as to how transitory inflation is,” adding, “But as long as the Fed believes it’s transitory, that is what matters for markets.”

The underlying concern being expressed by CFOs in the CNBC survey is rapidly rising wage inflation. Acquiring top-tier talent is getting highly competitive. Over the next six months, the largest group of CFOs (57%) expect the cost of labor to increase the most. The lack of available talent tends to trigger inflationary cycles and coming out of the pandemic has proved to be time where companies are growing faster than the market can supply the necessary skilled talent without offering higher wages and salaries.

This survey raises the short hairs on the back of my neck. CFOs have a clear pulse on input costs and particularly payrolls. Wage inflation has always been the fly in the economic recovery ointment and this time looks no different. There is a scarcity of highly skilled and qualified labor to manage high-end jobs.

This wage-push scenario could change the narrative if the Fed gets behind the curve – they may have to raise interest rates and otherwise tighten monetary policy sooner than they would like. If the Fed has to adjust their inflation outlook higher at future FOMC meetings and talk up “tapering” their bond-buying regimen on a shorter timeline, the market might not be as complacent as it has been of late.

However, over the past month, those fears have subsided somewhat, and the market has set a series of new all-time highs, primarily on the back of a significant development in the long-range view of inflation within the bond market, and the chart below illustrates why. Specifically, investors and economists most often look at the breakeven inflation rate of the 5- and 10-year spreads to measure inflation expectations.

After rising in May to their highest levels in about eight years, those breakeven rates have been falling consistently, indicating that investors no longer see inflation maintaining its hot pace far into the future.

Breakeven Inflation Rate Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The 5-year breakeven rate is now at 2.45% while the 10-year sits at 2.33%, indicating that the markets see inflation falling over a longer time frame. This move lower in the forward breakeven rate has been like a shot of adrenaline for growth stocks. This is reflected in the fact that big-cap tech is leading the market to new highs while the CBOE Volatility Index (VIX) is trading at a 2021 low of 15.10.

CBOE Volatility Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

As investors look to the second half of 2021 for clues, these data may provide the fuel for a rally to carry us higher. The notion of massive Congressional spending, which coincides with further QE and the tempered structural inflation expectations, provides a long glide path for stocks to continue to rally. Either the bond market is wrong or Ray Dalio, Larry Summers, and Mohamed El-Erian are wrong on the inflation picture.

The yield on the 10-year Treasury bond closed at 1.43% Friday, even after the jobs data came in above forecast. Nonfarm payrolls increased 850,000 in June, compared with the Dow Jones estimate of 706,000 and the upwardly revised 583,000 in May. The unemployment rate, however, rose to 5.9% against a 5.6% forecast. The headline numbers looked bullish, but the report also showed weaker-than-expected hourly earnings growth and length of the average work week, and no change in the labor force participation rate.

After Friday, the market is more convinced than ever that the Fed needs to take additional time before it moves to dial back its dovish policy of accommodation, as the June employment data still fell short of the Fed’s stated goal to get employment back to maximum levels in a broad-based and inclusive fashion after it showed much higher rates of unemployment for minority groups and no growth in participation rates.

Ten-Year Treasury Note Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The drop in the 10-year and longer end of the yield curve sends a strong signal that bond investors are fully in the “transitory” camp, which in turn is a green light for stocks, even at current levels.

While it can be argued that the market is technically overbought in the short-term, the vast liquidity on the sidelines bodes well for any corrections to continue to be great buying opportunities for equities.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

A Look Ahead by Louis Navellier
How Much Will 2nd Quarter GDP Grow?

Income Mail by Bryan Perry
What The Bond Market Is Saying About Inflation

Growth Mail by Gary Alexander
Is The Market Getting Ahead of Itself?

Global Mail by Ivan Martchev
The Dollar Looks Like It Wants to Run

Sector Spotlight by Jason Bodner
In This Age of Feelings, Facts are Still Safer!

View Full Archive
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About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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