Many, likely the vast majority believe that the recent wave of consumer price increases is going to stick around. It’s already painful and even if it isn’t inflation, they’re thinking, it soon will be. Maybe not 1970’s bad, not yet, at the very least something like then.
The bond market doesn’t just disagree, it keeps doing so vehemently. Nothing new, bond yields have signaled distrust and skepticism each and every time we go through one of these inflation panics. There was 2008’s fiasco today remembered for ending up more like the thirties than the seventies; renewal under QE “money printing” which very quickly deflated by 2011 and forgotten; then 2014’s “best jobs market in decades” simply vanished; finally, the 2018 “globally synchronized” comedy of hawkish errors.
Low yields aren’t just expressing some cynical opinion that we can quantitatively measure, the implications have been repeatedly proven true because those prices are largely made by those inside the shadows doing all the money. Or not enough, as the case has been.
Inflation, real inflation which lasts, is always and everywhere a monetary phenomenon. There hasn’t been the money for a long time, therefore there hasn’t been inflation. Instead, consumer prices, at times, have increased even jumped if only due to other factors which uniformly get verified as transitory.
That’s why I (and a very few others) become remorseless about being obsessively specific and demand full accuracy as to whether or not to call something inflation. Without the money, it won’t be so whatever else has to be responsible for consumer prices can only ever be transitory.
This time is different, everyone now says. Screw bonds! Sure, they’ve been on the spot predicting the Fed’s downfall since before 2008 (see: below) but more and more of late the Federal Reserve itself says you can’t rely on yields if or when the real inflation their QE policies have been desperate to inflict does arrive.
There’s been a curious uptick in scholarship purporting to study the best inflation prediction combinations. Most of them are just absurd fantasy, transparent attempts to discredit policymakers’ bond market nemesis. I’ll even give you a recent example, just a few days ago, published by the Cleveland Fed.
The study’s findings unsurprisingly disparage consumers, estimating that consumer surveys of inflation are the least helpful. Those conducted from businesses aren’t really any better, according to the Cleveland branch, while, predictably, the authors extol the virtuous capacities of “professional forecasters” as modern-day inflation oracles.
Professionals who just so happen to be – pure coincidence, I’m sure – formally trained Economists like the researchers in Cleveland and the rest of the Federal Reserve.
One other inflation predicting method included “financial markets.” This didn’t score so hotly, according to the paper:
Based on in-sample and out-of-sample predictive exercises, we find that the expectations of professional economists and businesses, as demonstrated by the Blue Chip and Atlanta Fed measures, have provided substantially more accurate predictions of CPI inflation one-year out compared to those of households. The accuracy of the Cleveland Fed inflation expectations model, which could be viewed as reflecting the expectations of the financial markets, is somewhat behind these other two measures.
Wait, back up; the Fed’s branch used an “inflation expectations model?” This is supposed to be a proxy for financial markets, but instead is:
Inflation expectations of financial markets, as captured by the model behind the one-year-ahead Federal Reserve Bank of Cleveland inflation expectations series. The Cleveland model (Haubrich, Pennacchi, and Ritchken (2012)) estimates inflation expectations using data that include nominal yields from US Treasury securities, survey forecasts, and inflation swap rate data.
It’s bad enough they’ve thrown a bunch of things into the wash and hope to extract something useful via subjective stochastics, but one of those things purportedly of financial markets is “survey forecasts.” I absolutely hate having to point out the implication of what sure seems like an intentional act of dirty pool.
Truth is, we don’t need all the fancy econometrics to evaluate these things; after all, these Economists have been employing exactly those for a very long time and they understand, appreciate, and can usefully forecast less and less by the year. On the contrary, we’ll just draw some simple charts and rely on nothing more than our eyes and common sense.
And we’ll start back in history with the last true bout of unbridled inflation, the supposed template for what so many people have been led to believe is about to make its ugly reappearance: The Great Inflation.
This part is exceedingly easy and straightforward since the bond market does all the work; you just need to be freed from the grasp of illiterate Economics.
Yields went down, not up, during the Great Depression (not pictured but I went into detail why here). They did so because of generally tight money (interest rate fallacy) that the Federal Reserve and its bank reserves (even based on gold flows) couldn’t manage. Banks, not central banks, are where the money comes from.
This deflationary situation did not change through and after World War II. Even during those three periods when consumer prices surged (sounds familiar), to the left of the red arrow above, bond yields didn’t budge an inch (I’ve already covered how it wasn’t the Fed’s yield caps which had kept yields low here). The financial market looked past those as temporary deviations which wouldn’t last because they weren’t actual inflation.
Transitory supply shocks don’t bother yields especially at the long end of the curve which measures money conditions through the prism of longer run inflation and growth perceptions. If it isn’t money, therefore transitory, longer bonds don’t price it.
Starting in the second half of the fifties, though, yields began at first gently rising (late fifties, eurodollar?), indicating that the tide was turning and whatever leftover remainders from the deflationary Great Depression were finally, mercifully being overcome.
What followed a double dip recession in 1958 then 1960 was a few years of low inflation. Yet, even during those, bond yields were moving higher anticipating what was about to come.
The 3-month bill rate bottomed out in July 1961 while longer end Treasuries would gently increase from January 1963. These then accelerated sharply in July 1965 well ahead of the first main eruption of consumer prices by February 1966.
That’s not all; a near-recession in 1967 granted a minor reprieve to consumers, a slowdown (slack) which Economists and central bankers mistakenly judged the end of the inflationary trend. The bond market, by contrast, picked up on the renewal of inflation three-quarters of a year ahead of time (bills almost half a year).
Bonds vs. Economists isn’t a new thing in the same way the Harlem Globetrotters didn’t just start pounding the Washington Generals yesterday.
Adding the Fed’s Discount Rate policy to the above chart (below) just highlights how bonds were way ahead as policymaker actions repeatedly fell behind:
The whole process repeated during and following the 1969-70 recession, too. LT yields bottomed out in March 1971, began moving higher even as the CPI leveled off and continued to decelerate for another fifteen months until June 1972.
Furthermore, this upward move in yields presaged a spike in consumer prices around early 1973 which itself predated the OPEC embargo’s painful inflationary oil contributions later that same year. As you can see on the chart above, bond yields incorporated the inflation part of the 1973 jump while trading underneath (CPI rates above yields) the embargo/crude oil components of it; in the same way as yields undercut those earlier pre-inflation supply shocks after WWII.
In other words, the bond market neatly and expertly compartmentalized inflation from other consumer price factors at the same time as helpfully foreseeing the former.
Contrary to what some Economists have claimed, the “financial markets” of little more than simply Treasury yields absolutely nailed the Great Inflation even as policymakers and experts fumbled around searching for answers and clues they would never find. Then-Federal Reserve Chairman Arthur Burns in August of 1971 had the nerve to say to Congress:
The rules of economics are not working in quite the way they used to.
The rules were always fine; Burns and those like him just didn’t understand how the monetary system had changed the way money worked within them. The bond market, the banks doing all the money, they had no problem sorting everything out.
OK, fine. This was a half century ago. What about something closer to today, the 21st century?
To start with, we’ve got yields moving higher in the middle of 2003 a year before the Fed’s eventual “rate hikes” which only then created confusion (“conundrum”) for Alan Greenspan when bond long end rates began to bunch up in anticipation of the decidedly high deflationary probabilities of the late eurodollar mania period.
The yield curve flattened, and then nominal rates began to fall by June 2007 long before any minus signs showed up in the CPI early in 2009.
What’s perhaps most powerful about the chart above is how the bond market (correctly) has treated each of the subsequent consumer price deviations dating back to the monetary breakdown during 2007: first in 2008, then again in 2011, and now in 2021.
Like those temporary supply shocks caught in the CPI’s of the immediate post-war aftermath, or the peak CPI created by the oil supply shock of 1973-74, bond yields also undercut each of those post-2007/broken eurodollar consumer price spikes…and are doing so yet again in 2021.
To really drive home this point, here are the two main charts one after the other, each one expertly sorting inflation from not-inflation by way of shadow money.
Quite simply, if it is actual inflation, yields go up as the market will price the real thing before it makes it into the CPI levels.
If there isn’t money for inflation, and those trading Treasuries know about shadow money that central bankers and Economists don’t and haven’t for more than half a century, then bond yields won’t chase these other CPI’s because those spikes aren’t inflation meaning they must be something else which, without the money, won’t last.
One of the key mistakes that Cleveland researchers and indeed all Economists make is treating all CPI increases as if they are the same; they keep searching for the best way to predict the annual CPI, rather than the proper way to sort out consumer prices! The reason officials keep committing such an egregious error is that Economics doesn’t even consider money. How could Economists? They haven’t taken the monetary system seriously since the Great Inflation shoved their ignorance into the limelight (criminally, the very same money ignorance the Great Depression had paraded before the world in a different way just a few decades earlier).
In lieu of this great deficiency, Economics has made it seem as if inflation is some voodoo mystery only its priestly class can describe from complicated mathematics rituals. You don’t need any of that, or them. All of this is publicly available, data, prices, everything, and it doesn’t take anything more than common sense divorced from that corrupted worldview.