Make it Make Sense

Yesterday saw the release of US GDP for Q1, and it came in well below expectations. Even though GDP came in at 1.6% growth – well below the expectations for 2.6% , bonds yields surged.

It may seem odd that after GDP missing expectations to the downside we see bond yields shoot up, right? I mean, shouldn’t decreasing GDP growth signal that the economy is slowing, and therefore interest rates could get cut soon? Normally, yes you would be bang on, however, contained within the GDP report was the inflation numbers for Q1, and they were less than optimal. Inflation stateside has re accelerated – again, and is heading in the wrong direction. US inflation for Q1 came in around 3.4%, against expectations for 2.5% increase

Growth down, and inflation up is not exactly the economic scenario anyone wants to see. In order for economies to enter stagflation, you need growth down, inflation up, and unemployment rising. So far the US has been able to keep the unemployment low, but for how long remains the question.

With inflation ticking up in both Canada and the US, commodities slowly grinding higher ( this will increase prices of fuels, foods, and raw goods ), and the renewal cliff in Canada costing more and more homeowners every month, it is really hard to see how rate cuts are imminent. Both the Federal Reserve and the BOC will be on the sidelines for at least a couple of months I would think, and potentially out into the end of Q3 or Q4. Every data point we are getting is suggesting that inflation is not going away and this will give pause – no pun intended for central banks to sit on their hands a bit longer.

Just on the US news yesterday Canadian 5 year yields shot up, closing out the day around 3.90%. Getting closer and closer to that 4.00% trend line. If we hit 4.00% and go lower, then 4.00% is acting as a ceiling, however if we push through the 4.00% rate, and hold above, then 4.00% becomes the floor, and we could go meaningfully higher from there. I personally think we bounce around the 4.00% range for a while ( + or – 8 bps intra day ) until we see some clear guidance from inflation and where it is taking us. Adding to potential inflationary pressures is the 40 billion of spending in the Federal budget. 40 billion dollars of newly created money will be out floating around the economy in the next 12 months. I say newly created because the government doesn’t have it, so they will have to print it, and sell bonds to cover it. Of course, they will also have to come up with some interest on those bonds to pay the bondholders.

Canada and the US need an inflation slayer, and I am not sure if the current heads of the Central Banks have the guts to be that person. In the 1970’s the US had Paul Volker. For all the crap he took, and all the pain he caused the average homeowner and person – he slayed the inflation dragon, and gave the US a good 30 year + run. Inflation is nowhere near where it was back in the late 70’s, but central bankers have also not come out to fight it with the same tenacity. Instead, they go month by month, data point by data point, and we lurch along. If Tiff and Co, or Jerome Powell were serious about getting rid on inflation, another 100 bp increase in the current rates would for sure put it to bed – not eased in, not 25 bps here and there, but 100 bps right at one time. That would cause a lot of pain for 90 to 180 days on everyone who didn’t have their financial shit in order, but it would stop inflation almost dead in its tracks. Inflation is a thief of purchasing power, and one of the most destructive forces in finance.

What is better? Going month by month, report by report, or stopping it dead in its tracks all at once? Both scenarios have their pluses and minuses. But, if you want to kill inflation for this cycle a bold move must be made, otherwise we will see this roller coaster up and down, sending people from hope to despair, and back again, while entire markets rise and fall on the news.