Inflation is no transitory joke …
Take it from someone who—unlike my peers—was originally in the transitory camp of inflation; after all, the tri-factor meta-trends of ever-lower US yields since the 1980s, deflationary forces of technology, and ageing demographics in most western and developed markets were goliath factors that have been running for decades.
Now it’s not so much that these meta-trends have been usurped overnight; it’s more the recognition of the fact that we could well be entering a medium inflationary regime which could run for years.
For context here is a table of recent inflationary prints across the globe (September 16, 2021)*:
*Worth noting that Australia and New Zealand CPIs are quarterly, unlike the default monthly figures for other countries. Sources are Saxo Bank and Bloomberg.
The fascinating thing you can see is that out of the major economies in the world, from both a DM and EM representation, the US is fourth in terms of having the highest inflation rate at 5.3%, but has a central bank rate of 0.0%—way lower than the +4.50% to +6.75% range across Russia, Brazil and Mexico.
If someone had told you in December 2019 that in 2 years’ time the US would be showing higher inflation than places like South Africa, Indonesia and India, alongside a central bank that had not hiked or tapered yet, they would have been laughed out of the room.
The other startling takeaway is the +3.2% to +3.8% range of inflation across the other DMs, with all of them having all-time low central bank rates. What is even more revealing of the inflection point, is when you compare the inflation and central bank rates pre-Covid (December 2019) and today (September 2021).
For instance, pre-Covid Norges bank’s rate was +1.50% with inflation running at +1.40%. Today inflation has more than doubled to +3.40%, while the Norges bank rate as of early September was sitting at 0.00%. It’s not hard to fathom a pathway where Norges bank returns to its +1.50% rate, if not higher, over the next 12 months.
Meanwhile in China, Indonesia and India, inflation has actually been falling from pre-Covid levels to the present. And in the case of China’s PBOC, they never cut rates during the Covid crisis.
Negative real rates reign supreme in developed markets …
Negative real rates seem to be a function of developed markets that have lost the ability to have true price discovery, and are instead influenced by synthetic pricing as a result of extraordinary credit growth. A key inflection point was seen in 1971 when Nixon took the US off the Gold Standard and with it, accountability. Also after the 2008 financial crisis, the predominant response from the US and most of the world was one of monetary policy expansion but fiscal policy restraint. Obama was a Democrat president and Congress was controlled by Republicans who, now being out of the White House, had found faith again in being fiscally conservative.
For additional context on the extent of this synthetic pricing that is prevalent in our markets, the Fed’s BS/GDP ratio grew from around 6% prior to the sub-prime 2008 crisis to a high of 26%, in measures that were supposed to be “temporary”. “Tapering” brought us back to a low of 18%, and then post-Covid we’ve seen that ratio spike to 38%. Now where could this number get to?
When Abenomics kicked off in the back end of 2012, the BoJ BS/GDP was around 28%. Today, less than 20 years later, it’s 133%, with no signs or indications of a reversal of policies to any kind of normalisation. The BoJ own the vast majority of the bond market in Japan and depending on whose data you trust, potentially up to 30% of equities. And this from the third biggest country that, unlike the US, is not even the global reserve currency of the world, with the deepest and most valuable equity, debt, real estate and intellectual property markets.
If we normalise the quarterly growth of the Fed Balance Sheet versus the S&P 500 from the end of 2007 to the end of August 2021, we can see that the Fed’s Balance Sheet grew by +935% versus the S&P 500’s +308%.
Source: Bloomberg and Saxo Group
The net result of all this liquidity in the system is developed markets that cannot reverse course back to a world of positive real rates. The political capital, will and courage is not there. Perhaps most alarming, the zeitgeist and the societal imbalances would just not stand for it. In the DMs we’ve just had the biggest wealth distribution from government balance sheets to its citizens and the vast majority are going to get used to this entitlement. And politicians being politicians, they will respond like monkeys, pushing the same button over and over all because it feels good and leads to their further entrenchment. The flawed incentives, vested interests of the elite, and lack of accountability and transparency from policymakers have DMs stuck in a vicious feedback loop that only compounds the house of cards that has been building since 2008.
Emerging markets are the only place to find positive real yields.
EM Asia is host to some of the biggest real rates yielding bond markets in the world. These include Indonesia (+4.5%), China (+2.1%), and Malaysia (+1.1%); contrast this with the negative rates to be found in the USA (-4.0%) and the Eurozone (-3.7%).
Source: Bloomberg and Saxo Group
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.