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Is this the Manchin rally? Bonds are rising and stocks at record high as spending expectations wane

World leaders from the Group of Seven are meeting in Cornwall, England, discussing plans for a global corporate minimum tax and to distribute COVID-19 vaccines, among other topics.

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You wouldn’t expect stocks and bonds to rise after a hotter-than-forecast inflation reading in a market that has been obsessed with the I-word, yet that’s what happened on Thursday.

With consumer prices excluding food and energy shooting up 3.8% year-over-year in May — the hottest reading since 1992 — the yield on the 10-year Treasury slipped 3 basis points, down to 1.46%. Yields move in the opposite direction to prices. The S&P 500 SPX, 0.12% finished at a record high, and the technology heavy Nasdaq Composite COMP, 0.15% has climbed four of the last five days.

Sure, there was some talk that what drove the consumer-price index higher were transitory items, like used-car prices, which should come back to reality once the semiconductor shortage is resolved, making new cars more easily obtainable. But a look at the Atlanta Federal Reserve’s breakdown doesn’t lend support to that interpretation. The sticky price CPI — that is, the cost of goods and services that are typically slow to change in price — shot up an annualized 4.5% in May, after jumping 5.5% in April. There haven’t been two back-to-back readings this strong in 30 years.

Kevin Muir, a former institutional equity derivatives trader turned blogger, called it the Manchin rally on his Macro Tourist blog. Sen. Joe Manchin’s unwillingness to go for a Democrats-only infrastructure package — on Tuesday, he said he wasn’t even thinking about using what’s called reconciliation, which would allow for passage without any Republicans voting — is tempering fiscal spending, as well as tax, expectations.

The West Virginia Democrat is part of a bipartisan group, which also includes another moderate Democrat, Sen. Kyrsten Sinema of Arizona, that is calling for $1.2 trillion in infrastructure spending over eight years, without tax increases apart from indexing federal gas taxes to inflation. That is well short of the $1.7 trillion President Joe Biden is seeking, who also calls for increased corporate taxes. Biden separately is calling for $1.8 trillion in investments in what he calls the American Families Plan, in areas like child care and healthcare, to be paid for by increased taxes on the wealthy.

“The firm rejection over the past several weeks of many of Biden’s tax increases,” added Joe Lieber, managing director at Eurasia Group, “is also likely to shrink a bill’s size to the bottom end of our base case $2-$3 trillion range, and increase reliance on deficit financing such a package.”

Reading the tea leaves in Washington is more art than science, but it is also notable this week that former Vice President Al Gore lobbied Biden to keep climate investments in the infrastructure package, a sign of the growing feeling that the president would accept a less sweeping deal.

“The 10-year yield continued to drop on Friday, sliding down to 1.434. U.S. stock futures ES00, 0.18% NQ00, 0.03% inched higher.”

World leaders from the Group of Seven are meeting in Cornwall, England, discussing plans for a global corporate minimum tax and to distribute COVID-19 vaccines, among other topics.

The University of Michigan’s consumer sentiment index for June highlights an otherwise quiet day on the economics front.

Tesla TSLA, -1.33% Chief Executive Elon Musk took a break on Thursday from his cryptocurrency tweeting to unveil the Model S Plaid, a high-performance version of the sedan.

Cinema chain operator AMC Entertainment AMC, 0.09% had its credit rating upgraded by S&P, due to the company raising cash by selling equity to meme-stock-obsessed investors. S&P nonetheless rates the chain as seven tiers below investment grade.

Chewy CHWY, -2.46%, the online pet-products retailer, beat expectations on earnings but also flagged the impact of labor shortages.

Vertex Pharmaceuticals VRTX, -8.74% fell 14% in premarket trade, as the biotech stopped development of a drug for a rare genetic disease, in what may be good news for Arrowhead Pharmaceuticals ARWR, 6.06%, which is working on a drug treating the same condition. Arrowhead shares rose 4%.

Finance

Tech Stocks Power Market to Record on All-Clear From Treasuries

For months, the threat of inflation grounded the tech stocks that drove the post-pandemic rebound. And yet, when data this week showed the threat is real, the Faangs took off.

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For months, the threat of inflation grounded the tech stocks that drove the post-pandemic rebound. And yet, when data this week showed the threat is real, the Faangs took off.

Investors in the tech megacaps can thank the bond market, where an epic change in sentiment sent 10-year yields tumbling the most in a year even after data showed inflation accelerated at the fastest rate since 2008 — normally a recipe for a spike in rates and trouble for stocks with high valuations. Instead, the Nasdaq 100 jumped 1.7% over the five days for a fourth straight weekly gain. The yield drop took the shine off value stocks, with banks slumping 2.4% in the week.

The signal from the bond market — that inflation isn’t a threat because the Federal Reserve is hellbent on keeping rates near zero — sets up a “great recipe for risk assets,” according to BNY Mellon Investment Management’s chief strategist Alicia Levine.

“The Fed has convinced everybody that they’re going to roll with it,” Levine told Bloomberg TV and Radio on Friday. “A mild inflationary environment is actually great for equities, it’s great for businesses, it’s great for wages and you don’t have a Fed that’s going to come and kill it all. So you’ve got cyclicals going and you’ll have tech going here.”

The Nasdaq 100 had languished as rising inflation was perceived as making tech shares’ already-stretched valuations impossible to justify. While investors rotated into value stocks for a while, the market’s loss of its heavyweight leader kept indexes in a rut since March.

The dam broke Thursday after the consumer-price reading came and went without market histrionics. The S&P 500 rallied to its first all-time high since early May and the Faang block climbed 0.6% in the week. The Russell 1000 Growth Index outperformed its value counterpart by 2.4 percentage points.

“The continuation of quantitative easing, the continuation of low rates is providing support to market multiples and perhaps to earnings”

Amazon.com Inc. jumped more than 4%, Twitter Inc. rallied 2.5% and Alphabet climbed 1.5% in the week. Meme stocks that captured much of the period’s headlines faltered along with Bitcoin.

Investors took solace from the nature of the rise in inflation even though it exceeded estimates, a third of the surge came from a jump in used vehicle prices, with airfare and hotels also rising — categories in stark demand as the economy reopens. Those price pressures are the type the Fed has been warning won’t be permanent.

And the central bank’s calculus is unlikely to change at next week’s meeting, meaning risk assets may continue their rebound. Policy makers are widely expected to stick to their ultra-easy monetary and downplay any risks from inflation. The bond market reflects as much, with traders closing out bearish positions en masse while trimming bets on Fed hikes.

“The continuation of quantitative easing, the continuation of low rates is providing support to market multiples and perhaps to earnings,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management. “That’s supportive for stocks.”

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Inflation scare? Look at this chart before freaking out

Breakdown of price rises not in line with enduring inflation surge, says UniCredit’s Vernazza

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Inflation is on the rise in America, but if price pressures were likely to persist, contrary to the Federal Reserve’s expectations, the data would be painting a different picture, one economist argued Friday.

In a note to clients, Daniel Vernazza, chief international economist at UniCredit Bank, highlighted the complicated but interesting facts below:

“Since higher inflation is largely explained by the reopening of the economy and supply shortages, it’s likely to prove temporary as the direct effects of the pandemic fade and supply adjusts to meet demand.”

The chart plots the change in prices (vertical axis) against the change in spending (horizontal axis) relative to pre-pandemic levels in February 2020, by industry. It uses the personal-consumption expenditures deflator instead of the consumer-price index because PCE is the Fed’s preferred measure of inflation and to make better comparisons with spending data.

It shows that most items have moved backward and forward along the horizontal axis, implying that prices have shown little sensitivity to changes in demand, Vernazza explained. And for service sectors hit particuarly hard by the pandemic, including airfares and accommodation, the reopening of the econony has led to only a partial recovery of prices, which are still not back to pre-pandemic levels.

It’s a somewhat different story for car rentals, where acute supply shortages have caused prices to surge, while spending in the sector remains well below pre-pandemic levels because of limited supply, he said. For used cars, the combination of a switch away from public transport by commuters and a global shortage of semiconductors for new cars has pushed up both demand and prices.

What’s important to note, Vernazza said, is that since higher inflation is largely explained by the reopening of the economy and supply shortages, it’s likely to prove temporary as the direct effects of the pandemic fade and supply adjusts to meet demand.

But what would a more enduring inflation threat look like?

In that case, most of the items would occupy the upper-right quadrant of the chart, reflecting what economists refer to as “demand-pull inflation,” Vernazza said. To date, “this is clearly not the case,” the economist wrote.

Higher inflation is typically seen as bad news for bonds, eroding the value of the interest payments delivered to holders. Stocks rallied Thursday, with the S&P 500 SPX, +0.19% edging to a record close on Thursday, while the Dow Jones Industrial Average DJIA, +0.04% remains not far off its all-time high and rallying tech shares, which are more sensitive to interest rates, pushed the Nasdaq Composite COMP, +0.35% higher.

The Federal Reserve holds a policy meeting next week. While Fed officials have largely stuck to their view that inflation pressures will prove “transitory,” several have also said it’s time to begin thinking about when it would be appropriate to discuss pulling back on asset purchases at the center of its extraordinary monetary policy efforts to support the economy and heal the labor market.

And some economists caution that signs of inflationary pressures in more cyclical segments of the economy are beginning to emerge.

“Both rent and owners’ equivalent rent have staged a clear turnaround over recent months, and food-away-from-home prices surged by 0.6%,” said Michael Pearce, senior U.S. economist at Capital Economics, in a note. “It is no coincidence that rents and restaurant prices are rising more rapidly when wage growth is also accelerating.”

Pearce said a continued surge in job openings shows that worker shortages “are real and intensifying.”

“The recent strength of inflation and signs of labor shortages could prompt a handful of hawkish regional Fed presidents to bring forward their projections for rate increases and strengthen calls for tapering asset purchases sooner rather than later at next week’s FOMC meeting,” he wrote. “But we suspect the majority on the committee will stick to the ‘largely transitory’ language and instead emphasize the yawning shortfall in employment from pre-pandemic levels.”

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Smiling G-7 Leaders Gather for ‘Wedding’ Diplomacy by the Sea

Leaders gather for the G-7 family photo in Carbis Bay, U.K. on June 11

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As Group of Seven leaders and their partners met on a drizzly English beach for their traditional “family photo,” they were reminded of another kind of formal — and potentially awkward — gathering of friends and relations.

“I feel like we are at a wedding”

“I feel like we are at a wedding,” Jill Biden, the wife of U.S. president Joe Biden, joked as leaders greeted each other with elbow bumps and quips. U.K. Prime Minister Boris Johnson — who married his third wife Carrie two weeks ago — agreed, saying the leaders’ procession resembled “walking down the aisle.”

The photo marked the official start of the group’s first in-person summit since the start of the pandemic. It’s also the first G-7 after Donald Trump’s turbulent four years in office, where he bickered with long-term allies, pulled the U.S out of the Paris climate accord and Iran nuclear deal, and most famously ripped up the communique at the end of the 2018 meeting in Canada despite having earlier agreed to it. So this gathering provides a chance for a reset, and for Biden to show that he means it when he says the U.S. is committed to working with other G-7 nations.

Over the next three days they will discuss boosting the global economic recovery from the coronavirus, strengthening democracies and taking firmer action to tackle climate change.

There is plenty of room for tension among the family of allies, with Johnson in an escalating dispute with European leaders over post-Brexit trade rules. As host, he will be working to keep the atmosphere friendly with lighter moments planned, including a barbecue on the beach and entertainment from a group of sea shanty singers.

It’s also the first G-7 for a crop of new leaders, including Biden. Standing in the back row for their first family photo were Japan’s Yoshihide Suga and Italy’s Mario Draghi. Still, Suga has attended many a G-7 when he was a top aide to previous prime minister Shinzo Abe, while Draghi is a veteran of plenty of high-stake meetings from his time as president of the European Central Bank.

Rounding out the picture were French President Emmanuel Macron, German Chancellor Angela Merkel, Canadian Prime Minister Justin Trudeau, plus European Council chief Charles Michel and Ursula von der Leyen, head of the European Commission.

Before any of the talking — or eating and drinking — had begun, the leaders’ wildly differing personal characters were already on full display.

With the photo shoot over, Merkel urged Johnson to take the others back to the summit center, telling him “you are the leader.” This is the last G-7 for Merkel after 16 years as chancellor of Europe’s biggest economy and key strategic power, because she is stepping down after an election in September.

But in a scene that would not have looked amiss after drinks at a wedding, Macron and Biden — meeting for the first time — threw their arms around each other and strolled along the beach boardwalk talking animatedly, apparently oblivious of others around them. They were making such slow progress that other leaders including Trudeau and Draghi were forced to trail behind while they continued their private chat. Eventually they stopped walking altogether, so Trudeau opted to circle around them and up the stairs off the beach.

Biden urged reporters and photographers who were there to watch it all to go swimming instead, quipping “everyone in the water.”

When he was asked what his message would be to Russian leader Vladimir Putin, when they meet for a summit in Geneva next week, Biden replied: “I’ll tell you after I have delivered it.”

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