How Afraid of Inflation should we be?

Inflation is the monster that destroys the stability of civilisations and the cause of many wars and civil unrest. However, the inflation narrative is currently all the popular media can talk about.

Inflation is the monster that destroys the stability of civilisations and the cause of many wars and civil unrest. However, the inflation narrative is currently all the popular media can talk about. Everyone with a social media account and any hint of interest in finance is talking about inflation.

The voices that matter most in these conversations are the voices of the Federal Reserve and the US Treasury Secretary. They are adamantly insistent that inflation will be high and will be transitory.

The speculative community are positioned for high inflation prints and nasty upside surprises. The short positions in the US Treasury Bonds (i.e. positioning to profit from higher UST yields) are at extreme levels (see image below). With the Fed persistently buying $120 billion worth of bonds a month in their QE programme, who will be the marginal seller?

Price action in the UST market indicates the pain will be felt if yields go lower, rather than higher, given that the US 10-year yield has been drifting lower regardless of the news flow recently.

Expectations for a high inflation print are near-universal now. It’s a given that it will be high, and will likely exceed expectations. But what if it isn’t and it’s below expectations? How narrow is the exit when the inflation-mongers (who are under-invested in risk assets, and short UST) need to cut their losses?

With stocks close to all-time highs, happy news on the inflation front will see the market ripping higher.

MARKET OBSERVATION

One Small Step For Bitcoin, One Giant Leap For Mankind

Once again, the Bitcoin narrative is shifting fast this time with El Salvador’s President Nayib Bukele taking the lead. As the Elon, China and FBI “Hack” FUDs (Fear. Uncertainty. Doubt) dies down, Bitcoin gets more desensitized towards such fearmongering and adjusts for the fundamental developments that are truly taking place (narrative arbitrage). Bitcoin is coming back strong with a couple of salvos of its own (like Sylvester Stallone from Rocky Balboa) and these are predicated on data and proven truths.

The Bitcoin community has been very advocative of debunking myths that Bitcoin is not competing for essential energy resources and producing a ton of carbon emissions, an argument the ESG crowd has been using to cause FUD in the initial selloff. However in the initial phase, it seems most of the counter-science by the Bitcoin community fell on deaf ears as price led the narrative and the reflexivity of the crowd believed the FUD (narrative mispricing).

Things somehow changed when El Salvador’s President passed a bill that made Bitcoin legal tender in the country and a good number of Latin American countries started to warm up to the idea. The gravity of the news seems to be shaking the previous bearish bias and we believe that people are starting to get more aligned with fundamentals again. Right after, Nayib Bukele tweeted that El Salvador is looking to set up a Bitcoin Mining industry using Volcanic Geothermal energy. Because of the “coolness” factor of using a Volcano and being 100% green, it will be the right kind of PR narrative (since the whole world is currently focused on El Salvador, let’s make a statement) to tackle the ESG FUD and shed light on amazing innovation that is occurring within the Bitcoin ecosystem.

More developing countries will follow this path as you get lots of free publicity and it does no harm to attract crypto capital into your country in times of Covid.

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DAY AHEAD

The ECB is likely to keep policy unchanged and ECB President Lagarde will likely remain dovish in her press conference after the meeting. German Zew economic sentiment index (Tue) and Eurozone GDP estimates (Wed) may be of interest but is unlikely to move markets.

US Consumer Price Index, CPI, is expected to rise +4.6% year-on-year. With heightened expectations of a high number, any disappointment on the downside will spark a risk asset rally as it will reduce the chances of the Federal Reserve having to taper its money printing policies anytime soon.

TRADING PLAN

1. Currencies: Keep short USD and long NZD, & CNH. Resistance for USDCNH is at 6.40–6.42 level, and it is getting stronger by the day. Stay short USD and Long CNH & NZD.

2. Commodities: Uranium — Long Uranium and energy stocks. Stay patient and invested.

Gold — Long Gold. Support for gold is at 1840–45. Stay long.

Key risks: Inflation fears which lead to higher US bond yields and a stronger USD.

3. Equities:

Equity Index: Long Nasdaq futures. Support is at 12,950–13,000. Reduce some longs as it nears previous highs, so that we can buy the dip should any occur. Stay long and patient.

Single Stocks: Risk assets are grinding higher, and cash is trash. Don’t miss out on the asymmetric opportunities we have highlighted in our TrackRecord Model Portfolio.

Key risks : Higher US yields due to inflation fears and geopolitical worries are the key risks.

WHAT HAPPENED YESTERDAY

Market movements as of New York Close 9 Jun 2021

The U.S. Dollar Index increased +0.1% to 90.14. Dollar was little changed and off session lows on Wednesday as investors focused on a European Central Bank meeting and the upcoming U.S. consumer price index report to help gauge the current pace of the economic recovery today. The Bank of Canada on Wednesday left its key interest rate unchanged (0.25%) as expected, and said it would maintain its current policy of quantitative easing. It also reiterated its guidance that rates would remain unchanged until at least the second half of 2022. GBP slid as Britain and the European Union failed to agree on solutions to post-Brexit trade problems in the British province of Northern Ireland, and exchanged threats in a standoff that could claim the G7 international summit.
US 2-yr Bond yield rose 2 basis points to 0.14%. 10-yr yield fell 3 basis points to 1.50%. The market traded in a narrow range as it awaits the US CPI data later today.
S&P 500 decreased -0.2% on Wednesday and was unsuccessful yet again at setting new all-time highs. The Nasdaq 100 (+0.03%) and Dow Jones Industrial Average (-0.4%) also closed slightly lower while the Russell 2000 (-0.7%) underperformed.
In the healthcare space, Merck (MRK 74.01, +1.64, +2.3%) signed a supply agreement with the U.S. government for a COVID-19 experimental pill. In addition, reports indicated that the government plans to purchase vaccine doses from Pfizer (PFE 39.81, +0.96, +2.5%) and Moderna (MRNA 217.44, +4.44, +2.1%) to donate to the world.

HEADLINES & MARKET IMPACT

U.S. senators push for infrastructure plan that avoids tax hikes

Notable Snippet: A bipartisan group of 10 senators is trying to craft a plan to revitalize U.S. roads and bridges without tax hikes, lawmakers said on Wednesday, though some of President Joe Biden’s fellow Democrats fretted that such an approach on infrastructure legislation would fail. Revamping America’s infrastructure is a high priority for Biden, but his sweeping $1.7 trillion proposal has run into trouble in a Congress that his party only narrowly controls, making Republican support pivotal.

THEMATIC CONTEXT: “Taxes are not even needed in the first place, evidenced by the ease of moving the tax% figures around in just a matter of weeks. We suspect that the talk about taxes is to preemptively set a precedent that such a measure will be used when the time comes, but does not carry much weight at this point in time.” — 4th Jun 2021

China’s highest producer inflation in over 12 years highlights global price pressures

Notable Snippet: China’s May factory gate prices rose at their fastest annual pace in over 12 years due to surging commodity prices, highlighting global inflation pressures at a time when policymakers are trying to revitalise COVID-hit growth. Investors are increasingly worried pandemic-driven stimulus measures could supercharge global inflation and force central banks to tighten policy, potentially curbing the recovery.

China’s producer price index (PPI) increased 9.0% (expected 8.5% after a 6.8% increase in April), the National Bureau of Statistics (NBS) said on Wednesday, as prices bounced back from last year’s pandemic lows.

THEMATIC CONTEXT: “We suspect that inflation is going to be anything but transitory in the longer term as the trajectory of domestic and geopolitical policies are not in the interests of lowering costs through globalization, but one of protectionism and instigation to form new alliances. We have 1. Reshoring of supply chains and building up of strategic reserves, 2. Return of the Labour Union in America, 3. Unlimited Fiscal spending fuelled by the Sputnik Moment in tech and 4. Rise of economic factions that are not in sync with a US led unipolar world.” — 17th May 2021

El Salvador becomes first country to make bitcoin legal tender

Notable Snippet: A majority of lawmakers approved a bill, which was proposed by President Nayib Bukele. The law will pave the way for the approval of bitcoin as legal tender in the South American country. The President has backed the cryptocurrency’s use in boosting the economy. El Salvador’s economy relies on remittances and those who are working abroad can send money back home in bitcoins.

“It will bring financial inclusion, investment, tourism, innovation and economic development for our country,” Bukele said in a tweet. He added that the use of bitcoin, which use will be optional, would not bring risks to users. Its use as legal tender will go into law in 90 days.