From Bond Economics (also on blogroll at right), June 13:
Although neoclassical macroeconomic theory does its utmost to obfuscate matters, monetary policy in practice is straightforward: central bankers react with a lag to economic data, and if they are panicked about inflation, they hike rates until something breaks. Although that description is more flippant than how conventional economists would describe the situation, it probably represents a consensus view. However, there is a hidden complexity: do things “break” because of rate hikes, or do they break on their own?
As the figure above shows, we are in the middle of commodity prices going parabolic, which is a typical mode of behaviour. I showed U.S. diesel prices, as refined products are in the worst shape in the petroleum complex. On a forward-looking basis, one of the three things must happen.
Petroleum prices continue to go parabolic. However, this scenario will eventually cause something to blow up. So far, the United States and Canada can absorb the higher prices (with a great deal of grumbling), but other countries are in a more exposed position.
Energy markets have reached “equilibrium” and will remain at a “permanently high plateau” near current levels. As the chart above shows, energy prices do enter periods of steady prices, they tend to have violent corrections in response to rapid rises.
Price violently correct to lower levels. They might bottom at higher levels, but there would be at least some relief in terms of the rate of change of prices.
The typical pattern of oil prices is to overshoot and violently reverse. Given the detachment of trading behaviour from fundamentals, I would have no confidence in peak price predictions. Instead, I think the forecast challenge is more time-based: how long until something blows up?
My view is that the main effect of policy rate changes is via the effect on the housing market. The fundamentals of the housing market are relatively slow moving, which means that I expect the oil price spike to reverse long before the housing market slows as a result of rate hikes.
Yeah, Bond Markets Probably Moving to Price a Recession
The 2-/10-year slope is relentlessly flattening, being on the verge of inversion territory at the time of writing. Flattening is entirely typical behaviour during a rate hike cycle — the long end does not rise one-to-one with the policy rate....
....MUCH MORE
