This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday
Welcome back. Inflation came in hot again, and the bond market did some things. Some thoughts on those things below. For those of you who are tired of repeated attempts to project a complete account of the world economy on to the poor little US yield curve, I’ve added some more thoughts on competition, as well. Email me: robert.armstrong
The bond market cares a little about short-term inflation but not one tiny bit about long-term inflation
The June consumer price index came in at 5.4 per cent higher than a year ago, even faster than May’s rise, with the stable “core” part of the index up 4.5 per cent. These are big numbers. For a few hours after the CPI report, though, the yield on the US 10-year Treasury note did basically nothing in response, which is interesting. Bond yields are meant to rise when inflation rises, because inflation is bad for the bonds.
The 10-year yield did finally move, and quickly, after Tuesday’s early afternoon Treasury auction of 30-year bonds had weak demand. Long bonds seem to have become rather self-absorbed: they don’t seem to care much about inflation, but they do care that people don’t want to buy them.
Even so, 10-year yields are still no higher than they were a week ago. The two-year note, however, did respond to the message about inflation right away:
What are we to make of this? My best guess is the market is saying something like this:
“Inflation is looking mostly transitory, but there is enough of it, and short-term growth looks good enough that the Fed will have to taper bond purchases in a little while, and raise short rates after that, so short yields need to nudge up. BUT these Fed moves will make it all but certain that inflation doesn’t get out of control, and indeed, growth isn’t going to be that great from here on out, so no need to bid up long bonds on inflation risk. Long yields are pretty unattractive here, though.”
Now, this is inelegant, but it fits the facts as we have them. That doesn’t mean it’s right. I think inflation may prove sticky after all; we just don’t know. But there is some evidence for the market’s apparent assumptions.
On the “inflation looks transitory” point, June’s price increases were, once again, very much driven by factors linked to reopening. Matt Klein at The Overshoot has a nice graphic of this:
On growth still not being that strong in the coming months, it does look as if Covid-19 will continue to be a headwind for the global economy. The Delta variant is awful. Eric Topol of Scripps Research tweeted this graph of death rates in low-vaccination countries, using data from Our World In Data. It is tragic:
That’s evidence. There is also the matter of sentiment, which is usually more important. The July Bank of America fund managers survey showed that the proportion of fund managers who thought that the economy would continue to improve from here has fallen from 91 per cent in March to 47 per cent now. Markets undershoot and overshoot. The market was giddy in March. It feels a bit dour now. Maybe long bonds have room to rise.
Competition, part 2
It remains unclear to me if weak competition is a problem for the US economy (and a boon to certain big US companies). What is clear is that a few companies make most of the profits, and that industry concentration — at least at the national level — is rising. But the link between these points and lack of competition is not certain.
My mailbox has rendered a few more relevant facts. Duncan Lamont of Schroders sent along the chart below, showing the steady decline of competition enforcement actions by the US government. I’ve seen some charts like this but this one, usefully, breaks out the different sort of investigations. The US still investigates mergers (even if it doesn’t block them), but it hasn’t bothered with monopolies in a long time and competition investigations (under section one of the Sherman Act, which forbids collusion among competitors) have become rare:
It may be there is less enforcement because there is less to enforce. But it is clear that the biggest, most profitable companies have been doing an absolute ton of acquisitions — about one a week through the 2010s for Amazon, Apple, Google, Facebook and Microsoft, according to Oliver Jones of Capital Economics. He sent along a note that included the following chart:
Jones writes of the mass acquisitions that they:
. . . would not have been possible in a pre-1980s style antitrust regime, and stopping it from continuing it is a key part of the current legislative drive in the US. The ability to buy would-be competitors while they are still small has, I think, made it easier for [Big Tech] to cement their dominance in a range of markets.
Jones points out that six antitrust laws have passed the House of Representatives judiciary committee with bipartisan support which would, if they became law: a) block acquisitions by major online platforms; b) make breaking up big technology businesses easier; c) stop big tech platforms from giving their own products preferential treatment; d) make it easier for users to leave big online platforms; e) make antitrust cases easier to bring; f) increase funding for antitrust authorities (you can read about the bills here, here, here, here, here and here.)
In addition, Big Tech pays low taxes by carefully locating subsidiaries, so it has a lot to lose from the current push for global tax reform. Jones writes:
If the tax and antitrust law currently in the pipeline passes (clearly still a huge if at this stage), I think it would change fundamental features of how the tech giants have operated over the past decade, chipping away at some of the key factors behind the consistently high and rising profits which underpinned their relentless outperformance during the 2010s.
I should point out that even if the current lax enforcement environment has contributed to the big tech companies’ striking dominance, and a change in that environment might make the companies less profitable, that still doesn’t prove that their dominance has made the economy less competitive. More on that question in the days to come.
One good read
My colleagues Laurence Fletcher and Tommy Stubbington have written a great piece on hard choices facing bond managers who claim to meet basic environmental, social and governance, or ESG, standards. Should they buy the bonds of regimes with bad records on human rights? The problem is that rough regimes is where the high yields are. Here’s a telling paragraph:
Many emerging market investors point to a dilemma for the industry: if they steer clear of Belarusian bonds, what about other countries with dubious human rights records? Many worry privately it would be hard to make money if the likes of Russia, Saudi Arabia or China were off-limits.
Having morals is going to hurt your returns, at least some of the time, and sometimes significantly. Avoid people who try to tell you otherwise.