Inflation,MMTandScarface

The US 10-year yield is trading at 1.50 currently, this is close to 50 bps move in a month’s time. Just for context, the central banks across the world hold close to 8 trillion Dollars of US treasuries, as the yields move up the price of their holdings goes down and they suffer MTM losses. US government bonds are the most liquid asset class on planet earth. The current sudden bout of yield move started today where an auction for 7-year treasury bonds saw tepid investor interest resulting in the jump in cut off yield. The US is however not alone where the yields are moving up. Japanese government bond yields have surged to their highest since 2016. The BOJ has officially accepted that YCC or yield curve control is a valid tool in their kit and want the 10-year level to be anchored around 0% (zero). The current level of 0.17% shows that the efforts to control the yield are not working as of now. In India the 10-year benchmark yield is also trading around 6.20% today.

Moving to the equity markets today, the markets are in the middle of a red pool. Dow Jones, Hang Seng, Nikkei, Indian Nifty all are nursing losses. The tech focussed NASDAQ had a real rough day with a 3.5% drop. We wrote some days back that rising yields will impact the companies disproportionately which have more promise rather than cashflows because that promise will now get discounted at a higher cost.

One question which we keep getting asked is that why was the inflation low for the last decade amidst the same easy money policy and what is changing now? To answer this question, we remember the 1983 Brian De Palma movie Scarface. In the movie, the protagonist Tony Montana (played by Al Pacino) keeps reminding himself of the golden rule of business, “Don’t get high on your own supply”. Had Tony been an economist he would do well to remember this rule in the current context too. The QE programs which started post GFC were feared to bring inflation. Many alarmist forecasts were made but the developed world saw none of it. The 2% CPI targets which countries like US, UK and EU follow were mostly undershot. A lot of possible reasons were touted especially like change in technology, ageing demography and increasing globalisation of the world. A more ageing population saves more and spends less, putting a downward pressure on prices. As the world becomes more globalized the supply chains can quickly shift base to cheaper locations maintaining the check on costs. Technology on the other hand eliminates cost pressures, it turns out that robots don’t negotiate their wages on a quarterly basis. All these reasons were “supplied” by central banks and economist alike and got assimilated as a belief system over the course of the decade. A new branch of “high” finance was created by the name MMT which played its role during the pandemic policy making when the flood gates opened, and liquidity was unleashed.

Now suddenly for last few days the markets are ignoring the dovish messages and factoring in the possibility of a steep inflation in coming days. Whether the reasons for low inflation were genuine or made up is still to be though.