Market Unprepared for Potential Inflation Resurgence

Market Positioning and Inflation

The market seems unprepared for a potential resurgence in inflation, as current positioning leans heavily towards stocks, bonds, and rates futures. Inflation has been put on the back burner for the moment, but as the saying goes, a watched pot never boils. Structural price growth remains high, and core consumer prices are still over 3%, suggesting that it may be premature to disregard inflation concerns.

Inflation Shocks and Historical Precedents

Historically, a shock often arrives just as inflation seems to be returning to a low and stable regime, causing prices to accelerate again. This was evident in the late 1960s when price pressures began to rise. Events such as Nixon closing the gold window in 1971, the Arab oil embargo in 1973, and the Iranian Revolution in 1979 turned that decade into the Great Inflation.

Current Market Positioning

As of September's PPI data, it's clear that the market is not anticipating any significant upside shocks. More worryingly, it appears unprepared for a potential trend of rising inflation. The chart below, based on HFR’s indices, shows inferred positioning for CTAs. A multiple regression on CTA returns versus the S&P 500 and Treasuries indicates that they are likely long and getting longer on stocks and bonds.

Additional Market Indicators

Additional market indicators corroborate this trend. The DBi Managed Futures ETF shows it has been getting longer on 2-year and 10-year note futures as well as long-bond futures. It is also long on the S&P, MSCI Emerging Markets index, and MSCI EAFE. Commitment of Trader positioning shows the net long of speculators in US stocks is rising. The US Bonds Position Proxy also shows a long in bonds that’s burgeoning outside of CTAs.

Implications of a Resurgence in Inflation

A resurgence in inflation would likely mean higher rates, lower bonds, and possibly lower stocks as valuations are affected by higher discount rates. With SOFR options implying a near-zero probability of an inflation tail, and current market positioning, it's clear the market is not prepared for such an outcome.

Bottom Line

With the market seemingly unprepared for a potential resurgence in inflation, it's crucial for investors to keep a close eye on economic indicators and adjust their strategies accordingly. What are your thoughts on this situation? Do you think the market is indeed unprepared for a potential inflation resurgence? Share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, delivered every day at 6pm.