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The bond market is torn over the potential for higher inflation and lower growth

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A man wearing a protective face mask walks by 14 Wall Street in the financial district of New York, November 19, 2020.

Shannon Stapleton | Reuters

A volatile environment for government bonds is reflecting a highly uncertain future for the U.S. economy, pointing to both slower growth and stubborn inflation.

After a burst higher earlier this year that scared markets, Treasury yields have fallen back sharply as investors have switched their focus from worries about price increases to the potential that the rapid burst in post-pandemic activity could start to slow down.

In the 1970s, the mix of higher prices and lower growth was called “stagflation,” a pejorative that has garnered little attention since then as inflation has remained tame over the past few decades.

However, the word is coming up more and more these days as the growth picture gets cloudier.

“The market is trading on the stagflation theme,” said Aneta Markowska, chief financial economist at Jefferies. “There’s the idea that these price increases are going to cause demand destruction, cause a policy mistake and ultimately that slows growth.”

For her part, Markowska thinks the trade that sent 10-year Treasury yields tumbling from a peak of around 1.75% in late March to about 1.18% earlier this week was a mistake. Yields trade opposite price, so a slump there means that investors are buying up bonds and pushing prices higher.

She sees a strong consumer and a coming eruption in supply, reversing the current bottleneck that has pushed prices to their highest levels since before the 2008 financial crisis, as generating plenty of momentum to keep growth cooking without generating runaway inflation. Markowska sees the Federal Reserve staying on the sidelines until at least 2023, despite recent market pricing that the central bank will begin raising rates in late 2022.

“Consensus is projecting 3% growth. I think we could grow 4% to 5% next year,” Markowska said. “Not only is the consumer still very healthy, but you’re going to have massive inventory restocking at some point. Even if demand comes down, supply has so much catching up to do. You’re going to see the mother of all restocking cycles.”

The bond market, which is generally seen as the more sober component of financial markets as opposed to the go-go stock market, doesn’t seem as convinced.

Low-growth world coming back

The 10-year Treasury is seen as the fixed income bellwether and generally a barometer for where the economy is headed as well as interest rates. Even with Wednesday’s rally in yields, a 1.29% Treasury is not expressing a lot of confidence in the future growth trajectory.

“Our view is growth and inflation moderate,” said Michael Collins, senior portfolio manager at PGIM Fixed Income. “I don’t care what growth and inflation looks like this year, what matters to our forecast of the 10-year Treasury is what it’s going to be like over 10 years. And I think it’s going to go back down. That’s the world we live in.”

The reference is to a below-trend growth environment with interest rates well below standard.

As the economy has grown out of the government-imposed pandemic shutdown, GDP has been well above the 2% or so trend that had been prevalent since the end of the Great Recession in 2009. The Covid recession was the shortest on record, and the economy has been a rocket since mid-2020.

But Collins expects the modest-growth world to return, and for investors to keep yields well within that a subdued range.

“The U.S. is going to continue to be a leader in global growth and economic dynamism,” he said. “But 1.5% to 2% is our speed limit on growth unless we have some productivity miracle.”

Measuring inflation’s impact

The looming question, then, is inflation.

Consumer prices rose a lofty 5.4% in June while the prices producers receive spiked 7.3%. Both numbers indicate continued price pressures that even Federal Reserve Chairman Jerome Powell acknowledged have been more aggressive and persistent than he and his central bank colleagues had expected.

While the slide in yields indicates that least some of the worry has come out of the market, any further signs that inflation will stick around longer than policymakers expect could change investors’ minds in a hurry.

That’s because of the swirling dynamics that threaten to raise that stagflation specter. The biggest growth concern right now centers on the threat that Covid-19 and its delta variant pose. Slowing growth and rising inflation could be lethal for the current investing landscape.

“If the virus begins to spread rapidly again, that would curtail economic growth and prolong the inflationary supply chain disruptions that have affected so many industries including semiconductors and housing,” said Nancy Davis, founder of Quadratic Capital Management and portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund.

“Stagflation is an even bigger risk for investors than inflation,” Davis added.

Collins, though, said he sees the current 10-year yield as trading around fair value considering the circumstances.

The Treasury market is often far more deliberate than its equity-focused counterpart, which can swing wildly on headlines both good and bad. At its current level, the bond market is taking a cautious view on what’s ahead.

With the stock market’s sensitivity lately to what’s been happening in bonds, that could mean some volatility on the equity side.

“Given what’s happened over the last 18 months and the problems much of the world faces over the next 2-3 years, a 1.2% 10-year is understandable,” wrote Nick Colas, co-founder of DataTrek Research. “It doesn’t mean equities are fated to have a tough remainder of 2021, or that a crash is imminent. It does mean that Treasuries have a healthy respect for history, especially the last decade’s worth of subpar U.S. inflation.”

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26-year-old American teaches English in South Korea: Advice to expats

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In November 2019, Michaela Cricchio, 26, booked a one-way flight to Seoul, South Korea, to teach English abroad.

Cricchio first heard about programs to teach English in a foreign country during an international studies class in college. When she couldn’t afford to move right after college, she spent a year and a half working on a cruise ship, where she could live rent-free, to save up.

After becoming certified to teach English and applying for a work visa, she was off to live on her own for the first time, and in a foreign country where she barely knew the language, no less.

“I remember sitting on the plane a year ago for my first year of teaching in South Korea and thinking, ‘What am I doing?'” Cricchio recalls. “Now, to actually be here and wake up every morning knowing I’m in a different country and so far away from home, it still hits me sometimes … I’ll realize that this is my life.”

The biggest misconception of living abroad

Cricchio loves her expat lifestyle. As a foreign English teacher, her school pays for her rent, which allows her to live in Seoul comfortably on $24,000 a year. During the weekends, she meets up with friends to visit cafes, restaurants, bars, art museums, parks, shopping districts and other city attractions.

But despite all the highs, she has one word of caution to other young people who want to travel the world and work abroad.

“The biggest misconception about living abroad is that it’s not all sunshine and rainbows,” Cricchio says. The Instagram photos and vlogs of people living abroad rarely cover the challenges and mundane parts of daily life, she says.

Michaela Cricchio’s school pays for her rent on a studio apartment in Seoul.

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For Cricchio, living in South Korea has been a major culture adjustment, since even basic errands like going to the grocery store can be challenging on her basic proficiency of the language. She still has work to do, bills to pay, health check-ups to schedule — she also still has to pay taxes to the U.S. government. “It’s still real life, just in a different place,” she says.

And teaching English grammar to elementary school students when it isn’t their first language is harder than you’d think, she adds.

Cricchio says it’s important to have realistic expectations in mind when making such a big life change. Also, it’s completely expected and normal to feel lonely during the experience.

She’s used apps to find English-speaking friends who are all in similar situations — young, newly independent and very far from home. “It’s really great to have your friends practically become your family,” she says. “But of course, there are times when I really miss my family. Being in this apartment alone at night, it gets lonely.”

FaceTime has become a lifeline for her to stay in touch with friends and family back home, including her parents and three older siblings. Sometimes, seeing them all together makes her even more homesick. But during those moments, she reminds herself that she’s living this lifestyle to learn and grow on her own.

Her No. 1 piece of advice

Still, Cricchio wouldn’t change the experience for anything. She hopes to continue building her financial cushion and finding opportunities to be a digital nomad, where she can move around, teach English part-time and freelance write about travel and teaching.

“Living in Korea has changed the way I look at my future,” Cricchio says. “Before, I was super afraid of the world, super shy. I wasn’t really sure about what direction I was going in.”

In the last year and a half, however, her confidence has skyrocketed. “It’s helped me grow up a lot. I 100% rely on myself here. I do have the help of my friends and school, but overall, I rely on myself a lot: financially, mentally, emotionally. I’m all I have.”

Michaela Cricchio uses apps to meet friends and fellow expats in Seoul.

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Elon Musk says Tesla will likely start accepting bitcoin again

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Tesla CEO Elon Musk said the company will likely start accepting bitcoin for vehicle purchases again.

“It looks like bitcoin is shifting a lot more toward renewables and a bunch of the heavy-duty coal plants that were being used…have been shut down, especially in China,” said Musk on Wednesday at The B-Word conference, an event hosted by the Crypto Council for Innovation.

“I want to do a little more due diligence to confirm that the percentage of renewable energy usage is most likely at or above 50% and that there is a trend toward increasing that number. If so, Tesla will most likely resume accepting bitcoin,” he said.

In May, Musk said on Twitter that the company would suspend vehicle purchases using bitcoin out of concern over the “rapidly increasing use of fossil fuels for bitcoin mining.”

Since then, Beijing has cracked down on crypto, expelling the country’s crypto miners, who have since begun to patriate elsewhere. New data from Cambridge University shows many miners are headed to the U.S., which is now the second-biggest destination for the world’s bitcoin miners.

The U.S. is home to some of the cheapest sources of power on the planet, which, more often than not, are renewable. Fred Thiel of Marathon Digital said most miners new to North America will be powered by renewables, or gas offset by renewable energy credits, and Compass CEO Whit Gibbs estimated that bitcoin mining in the U.S. is more than 50% powered by renewables. 

“Long-term, renewable energy will be the cheapest energy, but it doesn’t just happen overnight,” Musk said. “But as long as there is a conscious and determined, real effort by the mining community to move toward renewables, then obviously Tesla can support that.”

Bitcoin was trading nearly 8% higher on Wednesday.

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Tesla caused two-thirds of my personal, professional pain

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Elon Musk, founder of SpaceX and chief executive officer of Tesla Inc., arrives at the Axel Springer Award ceremony in Berlin, Germany, on Tuesday, Dec. 1, 2020.

Liesa Johannssen-Koppitz | Bloomberg | Getty Images

Tesla CEO Elon Musk said Wednesday that his electric vehicle and solar business could help bitcoin miners switch to renewable energy, but is currently limited by tight supply of battery cells.

He also acknowledged that Tesla is still not manufacturing its custom-designed 4680 cells for commercial use in electric cars or energy storage systems yet.

The comments came during an appearance at The B Word Conference, which was focused on bitcoin and other cryptocurrencies. During a panel, Square Crypto lead Steve Lee asked Musk what the energy-intensive bitcoin industry can do “to accelerate the transition to renewable energy” and “could Tesla Energy play a role?”

Musk replied, “Well, I think Tesla can play a role.”

Then, the 50-year-old CEO broke into a reflective moment, implying that Tesla’s entire reason for existence was to transition the world to clean energy.

“I would say I’ve had some pretty tough life experiences and Tesla’s probably responsible for two-thirds of all personal and professional pain combined to give you a sense of perspective there.”

Tesla’s energy business

Tesla has been selling commercial and residential solar installations since acquiring SolarCity in 2016 for around $2.6 billion, a deal that landed Musk in a Delaware court this month.

But before it got into the solar business, Tesla created and began selling energy storage products in 2015, including a backup battery for homes called the Powerwall, and larger batteries that can store solar or wind energy generated intermittently so it is available for use whenever utilities need it.

Tesla has installed a number of these utility-scale energy storage systems, Musk reminded his audience on Wednesday, that have helped utilities with “load-leveling the grid,” including in South Australia and elsewhere. But he noted that battery production was currently constraining produciton.

“In fact the limiting factor for us right now is cell production. So we need to both internally get our Tesla internal battery cells produced as well as increase supply from suppliers.”

Musk also repeated that even once Tesla can make its own battery cells, it will still rely on other battery cell makers. Its current cell suppliers include Panasonic, LG and CATL.

“Generally when I talk to our suppliers and they say ‘how many cells would you like?’ I say ‘how many cells can you make?’ you know ’cause sometimes they’re concerned, is Tesla gonna compete with them on cells? I’m like no no, if you want to make the cells be our guest. It’s just that we need a crazy number of batteries.”

In a Twitter exchange with fans after the bitcoin conference, Musk wrote that Tesla is still “not quite done” getting to “volume production” of its custom-designed 4680 battery cells.

He also acknowledged that Tesla sold Maxwell Technologies’ ultra-capacitor business and other assets to a San Diego-based startup called UCap Power, which is led by Gordon Schenk, preivously Tesla’s VP of sales for its Maxwell division.

Tesla initially acquired Maxwell in 2019 in a deal valued over $200 million. The exact terms of the sale to UCap Power Inc. were not disclosed, but may be discussed when Tesla holds its second-quarter earnings call on Monday, July 26.

Finally, at The B Word conference, Musk said energy storage systems, combined with solar and wind weren’t the only ways to transition bitcoin to cleaner energy. He endorsed existing hydropower, geothermal and nuclear energy to reduce the environmental impact of bitcoin mining.

“My expectation is not like that the energy production must be pure as the driven snow, but it also cannot be using the world’s dirtiest coal which it was for a moment there. So. You know, that’s just difficult for Tesla to support in that situation. I do think long-term renewable energy will actually be the cheapest form of energy, it just doesn’t happen overnight.”



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