Pretty interesting comments from this morning’s David Rosenberg piece. He cites the fact that inflation has tended to lag the business cycle and that bond markets are well aware of this phenomenon:
“Inflation is always and everywhere a lagging indicator, and the bond market is sophisticated enough to realize that.
- The YoY core inflation rate peaked at +2.5% in August 2008, fully eight months after the recession began.
- It peaked at +2.8% in December 2001, and that was also nine months after the onset of recession.
- It peaked in February 1991 at +5.7%, and that was seven months after the downturn started.
- It peaked in September 1981 at +11.8%, and this time there was a two month lag.
- Finally, in June 1980, it peaked at +13.6%, which was six months into the recession.
So the really big story here is that inflation lags the cycle and that the bond market will respond more to what is happening in the real economy – yesterday’s response being a classic case in point. Note as well how in each cycle, the peak in core inflation is getting lower and lower – hence so are the peaks in bond yields. And if the peak in core inflation this cycle is less than 2.5%, it will have been the first time that has happened since 1960. “
Very good stuff from Rosenberg. Inflation’s lag would also help explain why the Fed is so notoriously reactive to the business cycle rather than proactive. They are essentially waiting for lagging data to decide whether their policy approach is correct or not.
At this juncture the more important question remains – has core inflation peaked already or is the Fed behind the curve again in stopping out of control inflation? I personally agree with Rosenberg – the bond market has this one right (and amazingly, so does the Fed!). Given the lack of credit creation, moderate new money creation, high output gap, high unemployment, low wage growth, low unit labor costs and just generally stagnant economic environment I find it difficult to conclude that inflation is becoming a serious problem that policymakers need to respond to immediately.
Source: Gluskin Sheff