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Inflation Dead? Some Investors Bet It Could Roar Back

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Hedge funds are betting that inflation will pick up as central banks and governments world-wide print and spend vast amounts of money to support jobs and businesses hit by the coronavirus pandemic.

That bet goes against the weight of recent history.

Much of the developed world has grown accustomed to lower inflation since the early 1980s, and muted levels over the past decade.Plenty of investors have worried about inflation leaping since central banks began flooding markets with easy money following the 2008-09 financial crisis. They have been proven wrong. But if this year’s wave of stimulus measures—more aggressive and sweeping in scope—precipitate a sharp increase in the price of goods, financial markets may well be turned inside out.

Persistently high inflation can erode profits for companies that struggle to pass on price increases to customers, and leave consumers with less purchasing power if wages don’t keep pace. That could prove a mixed bag for stocks, and horrific for bonds, which would lose value given their currently low payouts.Inflation is unpredictable, and plays out in unpredictable ways.

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The average inflation for the next decade in the U.S., as implied by the gap between yields on the 10-year inflation-linked and 10-year Treasury notes, was 1.19% Friday. In the euro area, the same measure was 0.5%, using a 10-year inflation-linked German bund, according to data from Refinitiv. Inflation expectations in the U.S. swap market, where people hedge their exposure to price changes, was 1.3%. It was 0.7% in the euro area by the same measure.

The gold market suggests something different: Prices began surging in mid-March, when the Federal Reserve launched a string of programs to boost markets and support the economy. The metal is viewed both as a haven asset and what investors call a real asset, something physical that is judged to have intrinsic value in any economy.

How Long Until the Labor Market Recovers?

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Applications for unemployment insurance are expected to have declined for the eighth straight week. Bad news: The number of workers seeking assistance remains about 10-times higher than before coronavirus-related lockdowns began in March. The figures suggest the pace of layoffs is slowing as businesses slowly reopen and people start to move about more freely. But many economists expect a labor market recovery to take many months, if not years, to replace the tens of millions of jobs lost since February, Eric Morath reports.

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Wary of U.S. Crude, Investors Bet on Gasoline and Brent

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Wary of U.S. crude oil after prices sank below zero, investors are seeking different ways to profit from the energy market as pockets of the world economy emerge from lockdown.Some fund managers think it is safer, and will prove more lucrative, to invest in refined-oil products or in Brent, a blend of crudes produced in the North Sea. The hottest trade right now: gasoline.

A month ago, daily requests for driving directions on Apple Inc.’s Maps app had dropped almost 50% from mid-January, according to data from the technology company. As of May 8, that shortfall had narrowed to 24% with more drivers hitting the road.

That has helped push wholesale U.S. gasoline futures 38% higher over the past month to 97 cents a gallon ($40.74 a barrel) Friday. Retail gasoline prices rose for a second consecutive week to a national average of $1.83 a gallon on May 11, according to GasBuddy.

Refiners aren’t earning much money from making gasoline even at these higher prices.That is in part because sweeping production cuts, a pickup in road transport and the reopening of Asian economies have helped U.S. crude-oil prices rally after their historic crash last month. Futures contracts for delivery of West Texas Intermediate in June have recovered to $29.71 a barrel, almost triple their closing low on April 21. That came a day after contracts for delivery in May slid beneath $0, the first time WTI futures turned negative.

The gap between gasoline and crude prices stood at $12.24 a barrel Friday, 45% lower than a year before. That difference, known as the crack spread, roughly equates to a refiner’s profit margin for “cracking” crude into gasoline.

Gasoline prices will also outperform diesel until airplanes return to the skies in significant numbers. Diesel is in abundant supply because refiners diverted production away from jet fuel, and toward diesel, when planes were grounded because of the coronavirus pandemic. Adding to the pressure, journeys made using diesel are likely to fall as U.S. energy companies cut crude output. Oil producers are a major user of diesel-fueled trucks.

How the U.S. Could Really Hurt China

The U.S. determination that Hong Kong is no longer autonomous from mainland China has significant implications for the city’s exporters and businesses. But that could pale in comparison to further action by the U.S. to use its dominant position in the global banking system against Beijing.The most immediate threat is the possible end of the city’s special status as separate from mainland China for import and export purposes under the Hong Kong Policy Act of 1992. Sensitive U.S. technologies could no longer be imported into Hong Kong, and the city’s exports might be hit with the same tariffs levied on Chinese trade.

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But the act doesn’t cover the far more extensive role Hong Kong plays as China’s main point of access to global finance. That’s the context in which the Senate’s tentative discussion of penalties against banks that do significant transactions with “persons or entities that materially contribute to the contravention of China’s obligations” should be viewed.
As of 2019, mainland Chinese banks held 8,816 trillion Hong Kong dollars ($1.137 trillion) in assets in the semiautonomous city, an amount that has risen 373% in the last decade.
That’s just a sliver of China’s $40 trillion in total bank assets, but much larger in relation to the $2.215 trillion that the country’s banks extend to borrowers outside the mainland. China’s banks do much of their international business, mostly conducted in U.S. dollars, from Hong Kong. 

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Putting the ability of Chinese banks to conduct dollar-denominated activities at risk would be deleterious to China’s ability to operate financially overseas, posing a challenge for the largely dollar-denominated Belt and Road global infrastructure initiative. It would also put the more financially fragile parts of the country, like its debt-laden property developers, under strain.

Any action from the U.S. that strikes a serious blow to Chinese banks is likely to come in piecemeal stages rather than all at once. But the determination that Hong Kong is no longer autonomous could mark the beginning of a squeeze on China’s international financial operations, for which Beijing has no equivalent ability to retaliate.

Oversea Chinese Banking Corp Ltd 20200611 17.00

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