What a difference a month makes. Back in mid-May, most of the financial world seemed convinced runaway inflation was at hand. Spiking prices in lumber and other raw materials were just a foretaste, they said, and jumping long-term interest rates merely hinted at the pain to come as the economy overheated and prices skyrocketed. (Never mind that interest rates were already off their peak a bit by then.) But now the script has flipped. As noted in several outlets over the past week, lumber prices are now down nearly -50% from their early-May peak as supply has jumped to meet demand. Steel producers similarly ramped up output, and Treasury yields are down. All have seemingly defanged inflation dread, which we think speaks to the danger of reacting to whatever big story is circulating at any given time.
Now, as we wrote at the time, we never bought into the notion that soaring raw materials prices were a leading inflation indicator. They stemmed from temporary shortages colliding with strong demand as economies reopened and easing COVID restrictions enabled builders to ramp back up. It was only a matter of time, we argued, before high prices incentivized sawmills, miners and blast furnaces to turn up the dial so they could capitalize.
That seems to be happening now. A recent New York Times piece highlighted a flood of investment pouring into sawmills throughout the southern US, with idled plants going back online and operational plants adding shifts.[i] On the steel front, the World Steel Association reported Tuesday that global steel production jumped 16.5% y/y last month even as Chinese output eased a bit, thanks to soaring production in the US, Japan and India.[ii] Accordingly, steel prices have flattened out. Overall, it looks like those who thought runaway resources prices would be a lasting inflation trigger may have lost their argument’s underpinning.
Headlines might just now be noticing this, but markets seemed wise all the while. 10-year Treasury yields actually peaked on March 31, when they hit 1.74%.[iii] That was before everyone started freaking out over commodity prices. Before the CPI inflation rate accelerated to 4.2% y/y in April and 5.0% in May.[iv] Now the 10-year yield is down to 1.46%.[v] As a Wall Street Journal piece noted Monday, spreads between short and long-term rates are also down, implying investors seek a bit less of a premium to offset the risk of inflation longer-term.[vi] In other words, humans are starting to realize consciously what markets have been signaling at a subconscious level for weeks now.
In our view, the lesson here is simple, and it is the same one we made when covering May’s CPI report: Trust the market. It is the most efficient, smartest pricing mechanism on earth. If fears are raging and the market isn’t behaving like pundits think it should in light of those fears, we think it is a good sign the fear itself is wrong. That isn’t always true, but it is vastly more often than not, in our experience. It means the market is probably seeing through the noise and incorporating the high likelihood that things go better than everyone thinks. Yes, markets can be irrational in the short term. But if they are running opposite a prevailing narrative for weeks or months on end, then it probably isn’t the market that is irrational—it is the narrative.
Remember this the next time a big fear (or a supposedly huge positive, for that matter) storms headlines. If stocks and bonds act counterintuitively for a meaningful stretch of time, they are probably telling you something important.
[i] “As Lumber Prices Fall, the Threat of Inflation Loses Its Bite,” Matt Phillips, The New York Times, 6/21/2021.
[ii] “Global Steel Output Gains 16.5% in May, China Growth Cools,” Eric Onstad, Reuters, 6/22/2021.
[iii] Source: FactSet, as of 6/22/2021.
[vi] “Long-Dated Treasurys Win Favor on Receding Inflation Bets,” Anna Hirtenstein and Paul J. Davies, The Wall Street Journal, 6/21/2021.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.