Since the end of last year, we have repeatedly warned of the resilience of the US economy and the risk of secondary inflation. Recently, as the U.S. manufacturing, real estate, inventories, and capex cycles have gradually converged, strong growth and a persistently tight job market have proven economic resilience, with CPI rebounding to 3.5% year-on-year in March and core CPI flat at 3.8% year-on-year. On the basis of structural tightness in the labor market and the recovery in commodity price trends, we expect CPI to rebound to more than 4% YoY by the end of the year. In the medium to long term, given the obvious structural factors in this round of inflation, we expect the inflation pivot to rise significantly to more than 3% compared to pre-pandemic levels. This will have profound implications for asset pricing. First, the rebound in inflation will weigh on the performance of financial assets, especially interest-rate sensitive long-term Treasury bonds. Second, high inflation is good for commodities, especially copper, oil and gold. Finally, from the perspective of stock market style, during periods of rising inflation volatility, value performance tends to outperform growth, while the rise in interest rates makes funds more selective, which is relatively favorable to more cost-effective assets.
U.S. inflation, which is heating up again, and commodities that have risen in resonance, have been steadily moving away.
The starting point from virtual to real: In May 2022, we pointed out in "Asset Pricing in the Context of Macro Paradigm Changes" that the era of the Great Moderation over the past 30 years is gradually fading, and the world will usher in a new macro paradigm of higher inflation, higher interest rates, and increased macro volatility, which will favor three types of assets: physical assets, assets that can generate stable cash flows, and efficient productive assets.
Relay from virtual to real: In May 2023, based on an in-depth review of the four rounds of commodity supercycles over the past 100 years, and a detailed analysis of the supply-demand, savings-vs investment pattern in the post-financial crisis era and post-pandemic era, we judged that the fifth round of the commodity supercycle is expected to restart, but it still needs to be catalyzed.
Trigger of the commodity supercycle: In December 2023, we pointed out in "Between the Breakdown in 2024: Consensus and Variables in Overseas Markets" and "Early Interest Rate Cuts, the Confirmation of the End of the Low Interest Rate Era" that the U.S. economic cycle is expected to fully start in 2024, which will then drive the global manufacturing cycle to restart after two years, and the risk of reflation and even secondary inflation will intensify, and the copper-gold-oil cycle is expected to resonate.
Since the end of last year, we have repeatedly warned of the resilience of the US economy and the risk of secondary inflation[1]. Recently, as the U.S. manufacturing, real estate, inventory, and capital expenditure cycles are gradually synchronized, strong growth and a persistently tight job market have proven economic resilience, with CPI rebounding to 3.5% year-on-year in March, core CPI flat at 3.8% year-on-year, rising to 0.4% month-on-month, core services rising to 5.4% year-on-year, 5.2% previously, and super core services excluding housing 5.0% year-on-year, 4.5% previously. The risk of secondary inflation is hard to ignore. Inflationary pressures have led to another setback in interest rate cut expectations, with the 10-year Treasury rate surging to 4.5% at one point. On the basis of structural tightness in the labor market and the recovery in commodity price trends, we expect CPI to rebound to more than 4% YoY by the end of the year. In the medium to long term, given the obvious structural factors in this round of inflation, we expect the inflation pivot to rise significantly to more than 3% compared to pre-pandemic levels.
The multi-cycle simultaneous opening pushes up inflation
At present, the U.S. real estate, inventory, manufacturing, and capital expenditure cycles are rising simultaneously, supporting the continued heat of the economy. Since June last year, major home price indices such as FHFA and S&P have turned upward year-on-year (Chart 1), and in the four months since November, existing home sales have rebounded rapidly, exceeding expectations in a row, and new housing starts have exceeded expectations for three months, and signs of the start of the real estate upward cycle have become more obvious. As we point out in Between the Disruptions in 2024: Consensus and Variables in Overseas Markets, there is a structural shortage of supply in the U.S. housing market. After the 2008 financial crisis, housing starts were chronically low, resulting in a shortage of supply. The healthiest household balance sheets in 40 years, combined with the fact that millennials have entered the home-buying age in recent years, have brought about strong demand. Since the second quarter of last year, while the 30-year mortgage rate has climbed from 6.3% to 7.7%, new home loans for households have still bottomed out, with a cumulative increase of $1.2 trillion in the three quarters by the end of 2023, of which loans for people aged 30-39 increased by $362.8 billion. At the same time, the wealth effect brought about by the upward trend of the real estate cycle and the recovery of housing prices may form a positive feedback and continue to release the momentum of household consumption.
Chart 1: The real estate cycle begins
Source: Haver, CICC Research
The trend of rebounding in the inventory cycle is gradually determined. Total business inventories rose to 1.0% year-on-year in February, marking the third consecutive month of upward growth (Chart 2). Strong sales led to replenishment demand, and wholesalers' sales rose 2.3% month-on-month in February, far exceeding expectations of 0.4% and the previous value of -1.4%, driving wholesalers' inventory-to-sales ratio down to 1.34. We pointed out in "How New Changes in the U.S. Economy Affect Asset Prices" that this round of replenishment benefits from the terminal demand brought about by the resilience of the real estate chain and service consumption, which is reflected in the trend of replenishment in related industries such as furniture and furniture decoration, hardware and plumbing, clothing and apparel, commercial and professional equipment. The rebound in these downstream industries may continue to drive the recovery of upstream production and resource demand.
Chart 2: Inventory cycle on
Source: Haver, CICC Research
The upward movement of the manufacturing cycle is confirmed. Recently, the manufacturing PMI and the Dallas, Philadelphia and other local Fed manufacturing indices have rebounded in tandem (Chart 3), of which the ISM manufacturing PMI recorded 50.3% in March, returning to expansion territory for the first time since October 2022. Manufacturing construction spending continues to expand since the passage of the Infrastructure and Jobs Act, with spending 2.7 times higher than in September 2021, especially in the computer, electronic and electrical appliances sector, which is currently spending 11.8 times higher than in September 2021. This opens up a capital expenditure cycle while it is still ongoing. In 2022 and 2023, total S&P 500 capex increased by 20.6% and 16.5%, respectively. In terms of capacity utilization guidance for capital expenditure, capital expenditure is likely to maintain a high growth rate in 2024 (Chart 4). At the same time, we expect both total corporate capital expenditure and the net ratio of small business expansion capital expenditure to start to rise in the near term as banks' lending conditions for industrial and commercial loans to large and medium-sized enterprises and small enterprises become more marginally looser (Chart 5, Chart 6).
Chart 3: The Manufacturing Cycle Begins
Source: Haver, CICC Research
Chart 4: Capex cycle continues
Source: Haver, CICC Research
Chart 5: Marginal easing of credit standards may lead to an increase in total corporate capital expenditure
Source: Haver, CICC Research
Figure 6: Marginal easing of credit standards may lead small businesses to expand capital spending
Source: Haver, CICC Research
Under the combined effect of the four major cycles, the U.S. economy is prone to heat and hard to cold, superimposed supply shock disturbances, and the risk of secondary inflation has intensified. Looking at the outlook of the ISM manufacturing and services PMI price indicators on the CPI year-on-year, we expect inflation to pick up as a high probability event in the next six months (Chart 7). Sticky inflation is getting worse: On the one hand, services inflation has rebounded, with both core services and rent-excluded super-core CPI rising significantly month-on-month, near three-year highs (Chart 8), and on the other hand, the New York Fed's supply chain stress index continues to rise, leading to a year-on-year recovery in import prices (Chart 9), with the San Francisco Fed estimating that supply-side-driven core PCE inflation bottomed out to 1.4% in February (Previous value of 1.3%, see Chart 10). According to our model estimates, CPI is expected to recover to around 3.9% YoY and core CPI to 4.1% by the end of the year.
Chart 7: CPI YoY is likely to move higher with the PMI price index
Source: Haver, CICC Research
Chart 8: Core services CPI picks up month-on-month
Source: Haver, CICC Research
Chart 9: Import prices and pressure on the industrial chain have rebounded
Source: Haver, CICC Research
Chart 10: Supply-side PCE prices are likely to recover
Source: Haver, CICC Research
In "Between the Breakdown in 2024: Consensus and Variables in Overseas Markets" and "Early Interest Rate Cuts, the End of the Affirmative Era of Low Interest Rates", we pointed out that before the start of interest rate cuts, reflation is expected to be achieved with the reopening of the real estate and manufacturing cycles. After the start of interest rate cuts[2], terminal demand such as (durable goods) consumption and small enterprises will be effectively boosted, further stimulating investment (real estate, manufacturing) to further expand, and the economic cycle is expected to fully start, exacerbating the risk of secondary inflation. At the moment, if the geopolitical conflict escalates and the supply shock intensifies, we estimate that even if the rate cut is not started, the risk of secondary inflation may increase.
With the reopening of the U.S. cycle (which in turn led to the reopening of the global manufacturing cycle) and the recovery of inflation, we maintain our judgment since the end of last year: we are optimistic about the continued performance of pro-cyclical or inflationary assets such as copper, gold, oil, and industrial products in the next few quarters. Be wary of the risk of a short-term high-level correction, but it will not affect our optimistic judgment on the full year of copper oil and gold. Looking ahead, we like the copper-gold ratio to recover from its lows as the U.S. manufacturing cycle moves forward and the economy remains resilient (Chart 11).
Chart 11: The copper-gold ratio may have moved higher with the ISM manufacturing PMI
Source: Haver, CICC Research
Structural factors pushed up the inflation hub
The current round of inflation in the United States is not a short-cycle phenomenon, but a concrete manifestation of the structural shortage of supply and demand that has prompted the transformation of the macro paradigm from low inflation to high inflation (see Asset Pricing in the Context of the Great Change in the Macro Paradigm).
From the demand side, the U.S. fiscal continues to grow. Since 2018, federal finances have gradually shown a pro-cyclical pattern that has been rare since the end of World War II, that is, when the economy is stronger, fiscal strength is stronger, such as the unemployment rate trending downward or lower, while the deficit rate trending upward or higher (Chart 13). As we argue in "Broad Asset Classes in the U.S. Election Year: Finding Certainty in Uncertainty," a bipartisan consensus has emerged as a bipartisan consensus on a new supply-side economics that balances both the supply side and the demand side, and this will require sustained fiscal efforts. In fact, in the five months since FY2024, the underlying deficit remains strong and continues to support the economic boom (Chart 12). We expect the deficit to reach $1.6 trillion in fiscal 2024, just below the $1.7 trillion in fiscal 2023 (the third-highest deficit in history). At the same time, however, high interest rates are eroding the effectiveness of fiscal deficits, and interest expenses as a share of deficits have gradually increased since rate hikes (Chart 15), especially since the beginning of the fiscal year, where interest expenses have far exceeded historical seasonality (Chart 14). However, since the beginning of this fiscal year, the issuance of long-term bonds has continued to rise (the net issuance of long-term bonds in fiscal 2023 accounted for only 19%, compared with the net issuance of US$189.4 billion in the fourth quarter of last year, accounting for 31%, the net issuance of US$189 billion in the first quarter of this year, accounting for 33%, and the net issuance of US$265 billion in the second quarter, while the total net issuance of treasury bonds was US$5 billion), which may make this part of the debt lock in high interest rates and further erode the room for fiscal expansion. We expect that if the contradiction between big fiscal and high interest rates persists, it could increase the pressure on the Fed and force the monetary policy to match the fiscal (e.g., increase the Fed's holdings of Treasury bonds), which could lead to an uptick in the inflation pivot (Chart 16).
Chart 12: Underlying deficit strength remains strong in FY2024
Source: CEIC, CICC Research
Chart 13: U.S. Fiscal Tracker Has Been Pro-Cyclical Recently
Source: Haver, CICC Research
Exhibit 14: Interest expense has increased significantly since fiscal 2024
Source: CEIC, CICC Research
Chart 15: Decline in Underlying Deficit/Deficit Share Since Rate Hikes
Source: CEIC, CICC Research
Chart 16: Monetary and fiscal support for inflation
Source: FRED, CICC Research
On the supply side, the problem of supply shortage is more difficult to solve. We pointed out in "Asset Pricing in the Context of the Great Changes in the Macro Paradigm" and "The Special Valuation of China in the New Macro Paradigm" that the trend of de-globalization is causing a structural mismatch between supply and demand: the United States and other consuming countries are facing persistent supply shortages, coupled with the long-term underinvestment in the "old economy" such as energy, resources, and infrastructure since the 2008 financial crisis, and the formation of new supply is bound to be accompanied by the upward trend of the price center of physical assets such as resources. As the U.S. baby boomers exit the labor market, we expect labor shortages to remain a long-term problem, with a tight labor market creating inflationary pressures on wages (Chart 18).
Figure 17: The labor market remains structurally tight
Source: Haver, CICC Research
Chart 18: Tight Labor Market Pushes Up Wage Inflation
Note: The wage inflation gap is defined as the year-on-year reduction of ECI wages and the City Fed's 10-year inflation expectations
Source: Haver, CICC Research
Looking at supply and demand, we see a resurgence of the long-dormant positive correlation between output gap and inflation in the post-2008 global context of "ample supply and weak demand" (Chart 19). If the U.S. economy continues to have strong demand and insufficient supply under the support of big fiscal support, we believe that the rise in the inflation center will be a cross-cyclical problem. According to our model, the inflation pivot will be well above pre-pandemic levels in the coming period (Chart 21), averaging 3.5% over the next three years (2024-2026), compared to an average of 1.8% in 2010-2019. In the long run (2027-2033), if there are no major macro shocks, in the baseline scenario, we assume that the fiscal deficit widens according to the CBO forecast[4] and the Fed's debt holdings rise according to the trend after the 2008 financial crisis, then our model expects the inflation pivot to average 3.1% and rise to 3.3% in 2033 , and the upward trend is obvious, reaching 3.6% by 2033. If the currency remains independent and the Fed's debt holdings remain unchanged, we expect the inflation pivot to be relatively low at an average of 2.9%, but fiscal expansion still makes the inflation pivot more headwinding to the downside, with a final value of 2.9% in 2033. Either way, we expect the inflation pivot to be significantly higher than the pre-pandemic "three lows" period. As we have been emphasizing for more than two years, the Fed may eventually have to raise its inflation target and inflation tolerance to coexist with a high inflation hub[5].
Chart 19: The post-pandemic high output gap is pushing inflation up again
Source: Haver, CICC Research
Chart 20: CPI is expected to return to more than 4% by the end of the year
Source: Haver, CICC Research
Chart 21: We expect the US medium- to long-term inflation pivot to be above 3%.
Note: The inflation center is the 5-year moving average of CPI year-on-year
Source: Haver, Bloomberg, CICC Research
Asset pricing under a high inflation hub
This will have profound implications for asset pricing. First, the rebound in inflation will weigh on the performance of financial assets, especially interest-rate sensitive long-term Treasury bonds. Given that the resurgence of inflation has gradually materialized, we expect the bottom of the 10-year Treasury rate to be roughly in the range of 4.2%-4.4% before the start of the rate cut, and the start of the rate cut may stimulate US economic growth again, and the 10-year rate may rise again to around 4.5%-4.7%, depending on the strength of the US economy and inflation, the pace of the Fed's balance sheet reduction, and the strength of the "reverse distortion operation" (buying short bonds and selling long bonds). In the medium to long term, the 10-year interest rate pivot is likely to be 4.5%-5.0% (about 3%-3.5% inflation pivot + 1.5% real interest rate). This is basically in line with the 4.0%-4.7% we estimate in "Asset Pricing in the Context of Macro Paradigm Changes" and the 4.0%-4.5% measured in "Three Essays on the Peak of U.S. Treasury Interest Rates: A Natural Interest Rate Perspective".
Second, high inflation is good for commodities. On the one hand, most commodities (especially energy) are pro-inflation (Chart 22), and there is a clear co-directional relationship between higher-than-expected inflation (reflected in the rise in the inflation surprise index) and the CRB spot index (Chart 24). On the other hand, if secondary inflation materializes and inflation volatility rises again, it may further boost the relative performance of copper, oil and gold relative to the downward period of inflation volatility, while acting as a damper on stocks and bonds (Chart 23). At the same time, the resilience of cross-cyclical demand will increase the consumption of physical assets, especially the reopening of the real economy such as manufacturing, real estate, and inventories will be good for pro-cyclical resources such as copper and oil. As we pointed out in our article "Medium and Special Valuation from the New Macro Paradigm", a new real asset super is slowly unfolding (Chart 28), and not only traditional commodities, but also broad real asset investment such as power grids, transportation infrastructure, and production equipment may usher in a spring. In addition, against the backdrop of fiscal and geopolitical turmoil and the return of inflation, gold's valuations have deviated upwards from a negative correlation with real interest rates (Chart 25), reflecting more safe-haven and inflation-averse demand. Over the long term, there has been a significant positive correlation between the price of gold and the US government debt/GDP ratio since the end of the gold standard (Chart 26). We expect that if the big fiscal trend continues, fiscal dominance will return, which could further lift gold prices.
Chart 22: Copper, oil and gold prices have a strong positive correlation with inflation
Source: Haver, CICC Research
Chart 23: Commodities have fared better during periods of rising inflation volatility
Source: Bloomberg, CICC Research
Chart 24: CRB spot fluctuates with the inflation surprise index
Source: Haver, FRED, CICC Research
Chart 25: Gold price valuations have deviated from a negative correlation with real interest rates
Source: Haver, CICC Research
Chart 26: Government debt pushes gold prices
Source: National Mining Association, CICC Research
Chart 27: The share of companies making profits after IPOs in the US continues to climb
Source: Haver, CICC Research
Exhibit 28: The fifth real asset supercycle is in full swing
资料来源：Jacks, D.S. (2019), “From Boom to Bust: A Typology of Real Commodity Prices in the Long Run.” Cliometrica 13(2), 202-220.，中金公司研究部
Finally, in terms of equity market style, value tends to outperform growth during periods of rising inflation volatility (Chart 23), while higher interest rate pivots make funds more selective, favoring more cost-effective assets, such as value stocks with stable cash flows or high-quality growth stocks with solid earnings cash-outs. As we pointed out in "Early Interest Rate Cuts, the End of the Affirmative Era of Low Interest Rates", there is no need to panic too much about high interest rates, and the relative scarcity of funds brought about by high interest rates is more likely to play a screening role, and digging out the real profitable targets may instead contribute to the improvement of corporate efficiency and social total factor productivity (TFP). In terms of the percentage of companies that were able to make a profit in the year of listing, although 2023 was another year of high interest rates, 46% of newly listed companies in the United States achieved profitability, continuing the three-year upward trend (Chart 27). In the post-2008 era of low interest rates, this proportion has continued to decline, and the growth rate of the US economy and TFP has also been at the lowest level since the 1980s.
Risk warning: The recent rise in copper, oil and gold prices is on the fast side, and there may be a risk of volatility and correction in the short term.
[1] See "Early Interest Rate Cuts, the End of the Affirmative Era of Low Interest Rates", "Stopping Balance Sheet Shrinkage: From Financial Cracks to Fiscal Drives", and "How New Changes in the U.S. Economy Affect Asset Prices"
[2] Given that this is an election year, the Biden administration has a strong incentive to cut interest rates, and the persistently high U.S. Treasury interest rates are driving pressure on government and small business lending, we believe there is still a high probability of a rate cut this year
[3] Originally proposed by Yellen, see https://home.treasury.gov/news/press-releases/jy0565 for details
[4]https://www.cbo.gov/publication/59711
[5] See "Early Interest Rate Cuts, the Definitive End of the Low Interest Rate Era"
Article source:
This article is excerpted from: "The Second Inflation in the United States Begins to Emerge, and the Resonance of the Copper, Oil and Gold Cycle" has been released on April 14, 2024
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