What is New on the Macro Level? By Hubert Marleau of Palos Mgt.
Inflation is here!
A few weeks ago, we predicted that a point of inflation was possibly upon us and it was going to be reflected in the bond market. We suggested that the turning point was July 8, 2016. At that time, ten-year U.S. notes were trading at 1.35%, yields on tips were negative, gold was fetching $1,375 (15% more than it did a year ago), and consumer prices were less than 1% higher than the previous year. It appears we might be right. The headline CPI rose 0.3% between August and September, registering a year over year increase of 1.5% while core CPI was up 2.2% and running ahead of the Fed’s target rate of 2.0%.
At the time of this writing, ten-year notes were trading at 1.76%, yields on tips have turned positive and gold prices are $100 less than they were last July. Long term interest rates are essentially driven by rates of increase in employment, productivity and inflation. That being said, ten-year treasuries in the U.S. should trade between 1.85% and 2.70%, if the rational forces of the markets were left to execute their magic independently, free of interference. It may happen sooner than generally forecasted because many policymakers at the Fed expect headline inflation to beat the 2.0% target.
The luxury Yellen thinks the Fed has may soon change. Deflationary forces have abated amid firming commodity prices, there is a recent selloff in the dollar and a sustained labour market improvement. As a matter of fact, the inflation outlook is rising just about everywhere. The ebbing of deflationary forces has prompted us to pare many of our interest sensitive and defensive positions in favour of names that are likely to gain from profit increases stemming from inflation and builders of infrastructure plays.