We have reached an important juncture on sovereign bonds. WTI crude has fallen back from its recent highs, and Chinese iron ore prices are sliding on growth concerns. The Philly Fed survey for June showed in a nutshell where the US economy is heading. Six-month ahead forward-looking indices slid, according to one of the first manufacturing surveys of the month. There is a disinflationary impulse coming. Timing will be key, as investors look to rotate from risky assets back into government debt.
The largest deflationary impulse could eventually come from a fallout in private credit markets. Last week’s sharp move lower in the Virtus Private Credit Strategy Index may be a sign that the ‘bubble’ in private equity is beginning to pop.
Nevertheless, long-term inflation expectations are still rising. According to the Atlanta Fed, business inflation expectations spanning a longer horizon (5-10 years) jumped to 3.5%. This makes it much more difficult for the Fed to ‘look ahead’ and anticipate a moderation of inflation. The turning indicators right now (e.g., Philly Fed, NAHB) may not feed through to the hard data fast enough for any material Fed pivot until at least Q4, and perhaps even Q1 2023. This ultimately raises the risks of a deflationary bust in 2023.
There is another issue for investors to consider. The SRI-Hitotsubashi CPI (ex-tobacco) showed a jump at the beginning of the week starting June 6th. The y/y rate accelerated 0.96% to 1.24%. This lesser known weekly report may already be picking up the price increases promised by Japanese companies over the summer.
The extreme experimentation with MMT could still break at any point, and this remains the big risk for Treasuries. Currently, the BoJ is on track to purchase ¥10tr worth of Japanese government bonds in June. But they may not be able to defend their yield cap much longer, as the falling yen (now down to 135 against the dollar) adds to the price pressures facing Japanese businesses.
