Over the past several months we have talked often about the root cause of the current inflationary environment. We can argue at the fringe about supply constraints etc. but at the end of the day inflation is driven by excess levels of money supply and liquidity. M2 money supply soared in 2020 and 2021 while the Fed expanded their balance sheet by nearly $5 trillion. Too many dollars, euros, and yen chasing the same amount or fewer units. Demand soaring, prices up. I just paid $5.79/gallon for gas in Garden City, Long Island. We are all seeing it.
What goes up also comes down and while no one is talking about it, some things have already started to fall. M2 money supply growth is collapsing. Mortgage rates are higher than a year ago but lower than they were two weeks ago. UST 10Y yields two weeks ago 3.21%; today 2.75%. Housing starts looking softer. Higher prices are starting to impact and slow demand. Financial conditions have most certainly tightened with the Fed doing very little. As unpleasant as markets have been, slowing demand will most certainly bring about slowing levels of inflation, lower yields and increase the probability of the Fed being able to execute a “soft landing”.
Hourly wage growth is elevated but appears ready to decline. Nothing slows economic demand like making less per hour. Demand looks like it has peaked and wants to go lower. Inflation will follow. And the bond market will figure this out long before the Fed.
Yields don’t lie. Follow UST yields – they look like they want to go lower here, not higher.
Richard Barrett
Chief Investment Officer
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