Trumpflation is running out of gas

Bloomberg

Markets finally got a reminder that Donald Trump hasn’t forgotten his promise to boost spending and slash taxes, but that may not be enough to revitalize one of the more resilient reflation trades his win inspired.

In recent days, BlackRock Inc. Chief Executive Larry Fink and economists at Goldman Sachs have raised doubts on how fast any pro-growth policies like infrastructure spending, tax cuts and deregulation might materialize -- or whether the net effect of the policies will even be beneficial.

While U.S. stocks rose to records, the dollar jumped and Treasuries fell after Trump said Thursday that details on tax cuts would emerge within weeks, market-based measures of inflation expectations -- derived from the difference between yields on Treasuries and their inflation-protected brethren -- are trending lower.

“For the markets, the honeymoon is starting to end with Trump,” said Thomas Simons, senior economist at Jefferies LLC in New York. “We need to see something real -- we can’t just continue to base current pricing on some nebulous fiscal policy we don’t have any details on."

In the Federal Reserve’s statement on Feb. 1, officials deemed these market-based measures of inflation compensation "still low" despite the post-election run-up, implying any retreat in break-evens would be an argument against a meaningful acceleration in the pace of rate hikes.

In a sign of just how desperate the market is for information, break-evens pared declines after Trump told airline executives he’d have an announcement about a “phenomenal” tax plan within weeks.

That may not be enough. Trump’s proposals weren’t the only thing bolstering break-evens in late 2016. Higher commodity prices, buoyant data world-wide and firming wage growth will need to pick up the slack to jolt break-evens out of their plateau.

Favorable Crude Comps

An early progress report on the agreement between OPEC and non-OPEC nations to limit crude production will come on Friday and Monday, when the International Energy Agency and OPEC publish their monthly reports.

Two-year break-evens have shown a much stronger connection to daily movements in the front-month West Texas Intermediate contract than their counterparts at the five-year or 10-year maturities.

While this speaks to the importance of crude prices, it also casts doubt on the sustainability of pricing pressures once base effects fade. Gasoline prices are up more than 30 percent year-on-year, according to Bespoke Investment Group, their fastest advance since September 2011.

"Strong growth reported in U.S. shale production and the rig count rising lends support to the perspective that crude is probably range-bound for the next couple of years," said David Doyle, North American economist at Macquarie Capital Markets Ltd. "So that positive force that has been pushing break-evens higher looks to be stalling out a little bit here, and is no longer there as a big catalyst for a move higher."

Global Support

Right before the U.S. election, economic surprise indexes from a host of advanced economies and emerging markets broke into positive territory, a testament to the global underpinnings of the reflation trade.

But these surprise indexes are mean-reverting -- and their fluctuations tend to be driven more by changing expectations than data. While still solidly above zero, Citigroup Inc.’s surprise indexes for G10 economies and the emerging markets have shown signs of rolling over in recent weeks.

Most importantly for break-evens, however, is evidence from leading indicators that economic growth is poised to accelerate.

“At 2.3 percent, 2017 growth estimates are basically where they were last summer, even though growth has been stronger than 2.3 percent since then,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research. “So, I wonder if the consensus continues to revise up growth and we have more of a goldilocks-type environment, which could mean higher real yields, but leaving the cyclical bent in stocks intact.”

Pay Gains Slow

Meanwhile, despite continued strong job growth, three major indicators of wage pressures are suggesting that the labor market isn’t overheating in a manner that puts the U.S. economy on the verge of a cost led inflationary spiral.

"These are three classic wage tightness indicators that you can look to and say OK, things aren’t running so hot," said George Pearkes, macro strategist at Bespoke Investment Group. "Wages are a balance of supply and demand -- and I don’t think labor demand is in much trouble, but labor supply may have jumped up a little bit."

The sideways trend in the labor force participation rate and drop-off in the quits rate are two more elements that make the outlook for wage growth less robust than it was six months ago, Pearkes added.

"This is ironic, given how much other inflation indicators have moved," he said.