Minutes from the last meeting of the Federal Reserve Board were released earlier today. And to the surprise of very few people, they’re starting to talk about how they might “taper asset purchases.”
For those of you who might not be familiar with that terminology, it means that now that the economy is back on track, they’d maybe prefer to not continue buying $1.4 trillion dollars in U.S. government debt every year.
I don’t blame them… That’s a lot to choke down.
But it also means that a whole heck of a lot of purchasing demand for U.S. Treasuries — $80 billion per month for the 10-year, and $40 billion/mo. for the 30-year (aka mortgage-backed securities) — will eventually go away.
The last time that happened — back in 2013 — it caused a dramatically quick selloff in bonds. And interest rates — which move inversely to bond prices — spiked, moving from 1.6% to 3% within the span of a few months.
So it was really interesting to see rates move in the opposite direction today, falling three basis points to 1.31%.
The narrative that financial media seems to be attaching to that move is that the “Great Reflation Trade” is all over, and that inflation is over.
And I’m here to tell you right now, that’s wrong… It’s not going away, it’s changing.
Now, are we going to see declines in some commodity prices over the short term?
Crude oil in particular, down around 7% from its recent peak, has fundamental oversupply problems that are eventually going to catch the market by surprise.
But it’s not going back to $47 per barrel like it did last year during the COVID-19 lockdown.
It’ll go back to $55 or $60.
And while that’s not that bad on an absolute number basis, it still represents a 50-60% increase over last year, which is enormous.
It’s the same story with lumber and copper. Yes, they finally shook the rust off its supply chain. Yes, car manufacturers are slowing down. And yes, homebuilders are delaying purchases.
But they’re both still up about 40-50% over last year, which in turn was up 40-50% over 2019!
And that’s even before we take into account the industrial sector, where raw materials prices may continue to run higher.
Steel is now the No. 1 performing commodity since Nov. 1, up 156% over that time.
Iron ore, one of the raw materials used to make it, is up 83% over the sale period.
Even coking coal — the steel raw material left for dead by the investment community — is getting into the act, up an incredible 80% over the past two months!
All of these commodities are raw materials for housing, which means in turn that we should see all these price increases continue to show up in housing price appreciation, or HPA.
In their latest report released Wednesday, DC think tank AEI said the following:
“Despite higher mortgage rates than at the start of the year, supply constraints and Work from Home flexibilities are fueling the acceleration in HPA recently and projected through the summer.
Without additional inventory or higher mortgage rates to cool down HPA growth, we expect HPA rates to remain at double digit levels throughout 2021 and into 2022.”
Now factor in that “shelter” comprises roughly 40% of the Consumer Price Index — the Fed’s preferred measure of inflation.
Let’s do the math. 40% of 18% is 7.2%… which is a higher inflation rate than I’ve ever experienced in my adult life.
So sorry, market analysts… The “reflation trade” isn’t over.
It’s just changing.
All the best,