Well that didn’t take long. It is not even a week since the Yellen post FOMC meeting press conference. But the über doves (who are mostly all academics) are already condemning her critics as spreading “inflation hysteria.”
It all started with University of Oregon’s Tim Duy’s blog post titled “Fed Watch: Inflation Hysteria.”
It appears that a case of inflation hysteria is gripping Wall Street… Goodness, you would think it is 1975…
Tim goes on to show you why inflation is all under control and not a problem that any Central Banker should worry about.
We then had my favourite Dr Evil impersonator Paul Krugman follow up with a “yeah, I completely agree” post in the New York Times.
Krugman ends his post titled “British Lessons on Inflation Hysteria” with the following line:
So Yellen has history on her side.
Although Yellen might have recent history on her side, the longer history of Central Banks is filled with examples of currency debasement and run away inflation. I don’t think that ending your argument by claiming recent past is indicative of future results is a wise move.
Let’s have a look at this so called “inflation hysteria” that the academics claim is gripping Wall Street. I don’t know about Tim Duy or Paul Krugman, but I have seen a few hysterias in my day and it is indeed frightening when prices shoot straight up with no thought about the absurd rises. This “inflation hysteria” must be especially frightening because Wall Street must be scrambling to buy every inflation hedge in the book. Break-even levels must be exploding higher…
US 5 year Break Even level</a> </div>
Wait, that is the so called “inflation hysteria?” US 5 year break even levels have risen 15 basis points and these economists claim that Wall Street is over reacting to Janet Yellen’s dovish press conference?
Maybe I am missing something. Let’s try looking at the longer term chart…
US 5 year Break Evens level longer term chart</a> </div>
Holy smokes. This move has barely even started and already the academics are lambasting Wall Street as over reacting.
The idea that inflation is never going to be a worry has so completely infiltrated the public’s psyche that even the mention of the Fed Chairperson’s lack of concern about maintaining the purchasing power of money brings accusations of “inflation hysteria.”
Unlike Tim Duy and Paul Krugman, I make my living by betting actual dollars in the market. I am not nearly as “all knowing” as they are, but I have seen a few cycles in my day. And one thing I know is that no one can ever be as sure about an outcome as they seem to be regarding inflation.
This certainty is all the more perplexing because the actual inflation figures are all ticking higher. And it is not like monetary policy is especially tight either.
Yes, I acknowledge that the decline of the velocity of money during the past 5 years has caught a lot of inflationistas by surprise. The effects from the massive expansion of Central Bank balance sheets have been muted by this decline in velocity.
But how do we know that this velocity will keep going down? Given the massive expansion of the monetary base since the bursting of the 2008 credit bubble, the potential for an explosion in inflation if the velocity of money stops ticking lower is much higher than the academics summarily dismiss.
Sometimes on the trading desk when you disagreed with one of your co-workers in such a fundamental way, there was nothing more to do than to shut up and put your money where your mouth was. I find myself so at odds with Paul Krugman’s dismissal about the concerns about inflation that all I can say is “bought from you Mr. Krugman.” I will take the other side of your “inflation is not a worry” bet.
My guess is that Krugman and the rest of the academics will regret their nonchalance regarding inflation. I look forward to coming back to this post in a year or two. Maybe Mr. Krugman will be correct – I am not nearly as confident as he is. But I do know that his “what me worry” attitude is not the right way to bet…
Markets are a little too casual
I continue to be amazed at how much the markets seem to be ignoring the increasingly unstable geopolitical situation. The more I read about Iraq, the more scary it becomes. This is no longer just a rag tag bunch of terrorists that can be easily disrupted.
In trying to understand the situation, I try to find non-political analysis information streams and there is no better source than the Middle East Perspective blog by Rick Francona. His recent post about the military developments by ISIS show a level of sophistication that is not being appreciated by the markets. ISIS’ usage of social media is also scarily efficient. This meme of #BRINGBACKOUR HUMVEES is especially clever.
Between mocking the US and frightening the Iraqis into submission with videos of brutal executions, the ISIS are showing themselves as a formidable foe.
This problem is not going away any time soon. The Sunni / Shia conflict is so deeply entrenched in the Middle East that we in the West cannot even begin to understand. I just don’t see how this situation is going to do anything but escalate.
As the US is increasingly preoccupied with Iraq, other nefarious actors are going to take advantage of the perceived weakness. Whether it is Russia, China or Syria, the increasing geopolitical focus on Iraq will give them a chance to advance their cause.
I don’t expect the markets to go straight down because of these increased tensions. But I do think that they are acting a little too casual. The potential for a mistake that quickly escalates is much higher than the market is currently pricing. Make sure you pick up your cheap options now while they are being given away…