GLOBAL CREDIT BULLETS | Monday, 20th September 2021

US Inflation – half a year of “transitory”
US CPI increased 0.3% MoM (5.3% YoY) in August, slightly missing consensus estimates. Most of the miss was explained by re-opening sectors, such as transportation and hospitality. Rates markets slightly relieved on the print, but we don’t think the weaker read change the trajectory of US inflation too much. The composition of the print clearly points to a temporary weakening driven by delta variant concerns in summer, and most of it may subside once mobility picks up in September. Underlying inflation remains very strong, with August having been the 5^th print in a row above 4% and core components showing marked signs of strength. Shorter term, gas shortages may boost the energy component helping a quick recovery in headline measures. Stickier inflation is gradually feeding into consumers’ expectations, while markets and the Fed still foresee medium term levels around 2% (see Chart below).

Fed – waiting game
The upcoming Fed meeting should be a non-event. Since the dovish turn at Jackson Hole in late August, the ECB sounded patient and US inflation came weaker than anticipated. As such, there is little reason for the Fed to change guidance at the current meeting, especially as Covid cases just peaked but are still relatively elevated. More visibility on 2022 monetary policy is postponed to the November meeting, when the Fed is likely to start tapering, presumably at a shallow rate initially ($10-15bn initially). The rates market remains very complacent to inflation risk, with the 10 year Treasury trading 4% below the run CPI rate and well below the Fed inflation target. Breakevens continue to price a very transitory inflation dynamics, and carry trades came back in high demand. Rates peaked in February, and are now 30bp off the highs. A sudden increase in inflation employment may take place in 4Q, especially as consequences of the delta variant wave fade. The combination of better jobs and persistent inflation will inevitably trigger a Fed reaction, which the market has now largely priced out. We continue to think a sudden “inflation awake” is in the cards in the next 3-6 months, with the potential for a good amount of vol in rates and credit markets.

German Elections – turning left?
German Federal elections will take place on September 26^th, after almost 16 years of CDU ruling and Angela Merkel leadership. While polls displayed a pretty balance picture until early summer, the SPD (moderate-left party) is showing a big gain in the past few weeks. Polls from Politico taken on September 14^th show the SPD leading the CDU by a decently wide margin, 25% vs 21%. The CDU polls below 20% according to a few pollsters, the lowest level of the past 20 years. Greens are also doing well, hovering around 15-16% in polls. While a grand-coalition is probably still the base case, chances of a government without CDU are now higher. Two possibilities are a “traffic-light coalition” between the SPD, Greens, and FDP or a “red-red-green” coalition between the SPD, Linke, and Greens. A government without CDU would mark a big turn in Germany, as some of the hardest position on fiscal and monetary policy could soften after almost 20 years. EU rates markets have started moving since summer, but real and nominal yields remain largely in negative territory. European equities and banks have rallied in 2021 but display valuations which are much more attractive than tech-heavy counterparts in US and Asia. If a “left turn” in Germany adds to higher inflation and potential ECB tapering in 2022, higher rates and higher equities will remain the trade in Europe.