U.S. Service Industries Expand at Slower Pace Than Expected
Comment of the Day

July 06 2021

Commentary by Eoin Treacy

U.S. Service Industries Expand at Slower Pace Than Expected

This article from Bloomberg may be of interest to subscribers. Here is a section:

The services index of inventories also shrank, indicating that supply chain constraints continue to hold back economic activity. Supplier delivery times remain elevated due to truck availability, slower rail services, port congestion and container shortages, Nieves said on a call with reporters.

A separate gauge of inventory sentiment dropped to a record low, showing more service providers see their stockpiles as too lean. The index of prices paid for materials fell slightly, suggesting that while still elevated, the acceleration in cost pressures may be starting to cool.

Eoin Treacy's view

The argument inflation is transitory got a boost today with services data coming in weaker than expected. The challenge is that the labour market has been distorted by massive government intervention and global supply chains are simultaneously struggling to recover from the impact of the lockdowns. The tendency to focus on year over year comparisons further muddies the economic picture in most countries.
The bond market continues to behave as if inflation has peaked. There is no doubt that some prices will retreat. Lumber already has and nothing has happened to question the cyclicality of the semiconductor sector. Oil prices also posted a downside key reversal today suggesting a peak of at least near-term significance. Meanwhile copper is the primary secular bull market contender.

10-year Treasury yields are back testing the region of the 200-day MA and a clear upward dynamic will be required to confirm resistance in this area.

Pushing out the timeline to normalization of policy weighs on the banking sector and suggests the sector is prone to a further process of mean reversion.

The gold price has been moving in lock step with the bond price since last year and both instruments peaked within a couple of days of each other in August. Bond prices broke out to new recovery highs today but gold was unable to hold the intraday peak.

The logic for why gold should rally is pretty clear. Any delay in normalizing policy means more money printing and loss of purchasing power for fiat currencies. However, the sector has been slow to attract adherents because of the relative strength of technology and growth shares amid the continued abundance of liquidity.

The UK’s Office for Budget Responsibility highlighted today that public finances are 6 times more sensitive to interest rates than ahead of the pandemic. That highlights the condition of public finances for most countries. The convexity of the bond market has exploded as a result of the global response to the pandemic.

The hit to government spending and tax hikes required to meet rising debt servicing costs mean central banks are in no position to raise rates. Inflation and growth need to be trending higher in a convincing manner before such measures can be considered. To rush the process would invite recessions which would only require even more money printing. That suggests we are still a long way from policy normalization. As that reality is digested by investors the argument for a hedge in the form of a hard asset should support gold prices. It is certainly helping to support bond prices today. 

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