Week ending 11th February 2022.

The big event of the week was the release of the latest US CPI inflation reading – and yet again, the reading came in higher than the major economist expected, at 7.5% versus their expectations of 7.3%.

We aren’t really sure why these major economists keep getting their expectations wrong: inflation is a lagging economic indicator, which means it should be relatively easy to estimate – and as we have repeatedly said much of this current rise in inflation has been driven by supply-chain disruptions rather than a sharp rise in demand (as evidenced by the number of companies we hear talking about supply disruptions and bottlenecks), coupled with higher commodity prices.

For example, the price of a barrel of Brent oil is over 50% higher than it was a year ago (and nearly 15% higher than it was at the start of this year) – hence why we have consistently warned that the risk is skewed towards higher inflation readings in the short-term.

Although there is a growing list of reasons to justify slightly higher interest rates, financial markets still don’t appear to appreciate that policymakers are powerless to affect much of today’s artificial inflation.

And likewise, we also believe that financial markets are underestimating the speed with which inflation can decline – in fact, Goldman Sachs this week said that they see the US central bank increasing US interest rates seven times this year due to high inflation, while James Bullard (the President of the Federal Reserve Bank of St. Louis) said he supports raising US interest rates by a full percentage point by the start of July and that he is open to considering an inter-meeting increase in interest rates before the Fed’s next scheduled policy meeting on 16 March 2022.

We believe that this sort of talk is not just aggressive, but actually way over the top. For example, an inter-meeting increase would actually hurt the Fed’s credibility as they have previously made it very clear that they will not increase interest rates while their QE program (bond buying) is still running (and it is not scheduled to end until their March meeting).

While we can easily see the Fed kicking off with a 0.5% interest rate increase in March, we would view this as a way of front-loading its monetary tightening, which would then allow them to take it slow to see if inflation does in fact start to slow as last year’s increases become this year’s ‘base effects’, and to see how economic growth is being impacted by the higher energy costs and the fiscal tightening.

Looking ahead to this coming week, we have minutes of the last Fed meeting (held on 26 January 2022), along with UK, Chinese & Japanese CPI inflation; US & Chinese PPI; US & UK retail sales; Eurozone & Japanese Q4 GDP; and UK employment data (unemployment rate and weekly earnings).

The Investment Management Team