There once was a concept, inflation
That frightened the heads of each nation
As prices would rise
They could not disguise
The fact it was just like taxation
But now, though it seems quite insane
Most governments try to explain
No need for dismay
There’s no reason you should complain
The latest example is from
The UK, where people’s income
Continues to lag
Each higher price tag
And prospects for growth are humdrum
It certainly is becoming more difficult to accept the idea that the current inflationary surge being felt around the world is going to end anytime soon. I keep trying to imagine why any company would cut prices in the current macroeconomic environment given the amount of available funds to spend held by consumers everywhere. So called ‘excess’ savings, the amount of savings that are available to consumers above their long-term trend, exceed $3 trillion worldwide, with more than $2 trillion of that in the US alone. If you run a company and are being faced with higher input costs (energy, wages, raw materials, etc.) and there has been no reduction in demand for your product, the most natural response is to continue to raise prices until you find the clearing price where demand softens. It is a pipe dream for any central bank to expect that the current situation is going to resolve itself in the near future.
And yet…the major central banks (Fed, ECB, BOE and BOJ) continue to be committed to maintaining ultra-easy monetary policy. For instance, today’s inflation data from the UK is a perfect case in point. CPI rose a more than expected 4.2% Y/Y, more than double the BOE’s price target. Core CPI rose 3.4%, also more than expected and RPI (Retail Price Index, the price series that UK inflation linked bonds track), rose 6.0%, the highest level since 1991. And yet, the BOE is seemingly no closer to raising rates. You may recall that despite what appeared to be clear signaling by the BOE they would be raising interest rates at their meeting earlier this month, they decided against doing so, surprising the market and leading to significant volatility in UK interest rate markets. In fact, BOE Governor Bailey fairly whined afterwards that it was not the BOE’s job to manage the economy. (If not, what exactly is their job?) At any rate, the growing concern in the UK is that growth is slowing more rapidly while prices continue to rise. This has put the BOE in a tough spot and will likely force a decision as to which issue to address. The problem is the policy prescriptions for each issue are opposite, thus the conundrum.
The bigger problem is that this conundrum exists in every major economy. The growth statistics we have seen have clearly been supported by the massive fiscal and monetary policy expansion everywhere. In the US, that number is greater than $10 trillion or 40% of the economy. The fear is that organic growth, outside the stimulus led measures, is much weaker and if policy support is removed too early, economies will quickly fall back into recession. In fact, that is the most common refrain we hear from policymakers around the world, premature tightening will be a bigger problem. Ultimately, a decision is going to need to be made by every central bank as to which policy problem is more important to address immediately. For the past four decades, the only policy issue considered was growth and how to support it. But now that inflation has made a comeback, it is a much tougher choice. We shall see which side the major central banks choose over the coming months, but in the meantime, the one thing which is abundantly clear is that prices are going to continue to rise.
A reasonable question would be, how have markets responded to the latest data and comments? And the answer is…no change in attitude. Risk appetite remains relatively robust as the money continues to flow from central banks, although certain risk havens, notably gold, are finding new supporters as fears of significantly faster inflation grow.
So, let’s survey today’s markets. Equities have had a mixed session with Asia (Nikkei -0.4%, Hang Seng -0.25%, Shanghai +0.45%) and Europe (DAX +0.1%, CAC +0.1%, FTSE 100 -0.3%) all, save China, remaining near all-time highs (in the case of the Nikkei they are merely 31 year highs from after the bubble there), but certainly showing no signs of backing off. US futures are showing similar price action with very modest movement either side of flat.
Bonds, as well, are little changed and mixed on the day with Treasuries (-0.5bps) catching a modest bid after having sold off sharply over the past week. In Europe, the price action is similar with Bunds (-0.3bps), OATs (+0.2bps) and Gilts (-0.5bps) all within a few tics of yesterday’s closing levels. I would have expected Gilts to suffer somewhat more given the UK inflation data, but these days, it appears that inflation doesn’t have any impact on interest rates.
Commodity prices are softer this morning led by oil (-1.3%) and NatGas (-1.75%), although European NatGas is higher by more than 7.3% this morning as Russia continues to restrict flows to the continent. (I have a feeling that the politicians who made the decision to rely on Russia for a critical source of power are going to come under increasing pressure.) In the metals markets, industrials are mostly under pressure (Cu -1.0%, Sn -0.1%, Zn -0.8%) but we are seeing a slight rebound in aluminum (+0.6%) and precious metals are doing fine (Au +0.6%, Ag +1.1%). It seems that inflation remains a concern there.
As to the dollar, it has outperformed a few more currencies than not, with TRY (-1.25%) the biggest loser as the central bank there has clearly made the decision that growth outweighs inflation and is expected to cut interest rates further despite inflation running at nearly 20%. Elsewhere in the EMG bloc, the losers are less dramatic with MYR (-0.3%) and CLP (-0.3%) the next worst performers. On the plus side, RUB (+0.8%) is the clear leader, shaking off the decline in oil prices as inflows to purchase Russian bonds have been enough to support the ruble. Otherwise, there are a handful of currencies that have edged higher, but nothing of note.
In the G10, the picture is also of a few more losers than gainers but no very large moves at all. surprisingly, GBP (+0.1%) has done very little in the wake of the CPI data and actually SEK (+0.35%) is the best performer on the day. However, given the krona’s recent performance, where it has fallen more than 4% in the past week, a modest rebound should not be much of a surprise. Overall, the dollar has retained its bid as evidenced by the euro (-2.8%) and the yen (-2.0%) declining during the past week with virtually no rebound. It appears that the market continues to believe the Fed is going to be the major central bank that tightens policy fastest and the dollar is benefitting accordingly.
This morning’s data brings Housing Starts (exp 1579K) and Building Permits (1630K), neither of which seem likely to move markets. Yesterday’s Retail Sales and IP data were much stronger than expected, which clearly weighed on bond markets a bit, and supported the dollar, but had little impact elsewhere. We hear from seven! Fed speakers today, as they continue to mostly double down on the message that they expect inflation to subside on its own and so it would be a mistake to act prematurely. There is a growing divide between what the market believes the Fed is going to do and what the Fed says they are going to do. When that resolves, it will have a large market impact, we just don’t know when that will be.
For now, you cannot fight the dollar rally, but I will say it is getting a bit long in the tooth and a modest correction seems in order during the next several sessions. Payables hedgers should be picking spots and layering into hedges because the longer-term situation for the dollar remains far more tenuous.
Good luck and stay safe