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2023 News Memo – Inflation Edition

Some observers would not be too far off in concluding that the most recent inflation narrative begins with the word 'transitory'. This word could be commonly accepted as meaning 'in passing'. By now some readers are probably wondering why an inflation narrative, a global one at that, would begin with a word such as transitory. Well, this is because the word transitory was Jerome Powell's go to word in describing the inflationary environment which ensued after a record amount of $15 trillion, as estimated by Reuters, was envisioned to be printed into monetary circulation by global central banks as a response to the covid-19 pandemic's financial impact - other media outlets describing its disruption as something not seen since the 1918 - 1920 Spanish influenza. The level of quantitative easing resulting from the United States's government response to the covid-19 pandemic is recorded as resulting in the country's worst inflation in 40 years. Certainly not a pretty picture for the world's current leading economy by Gross Domestic Product.

To put the above into perspective, the Federal Reserve began its current interest rate hiking cycle on March 17th, 2022 with a 25 basis point increase. This was soon followed by an increase of 50 basis points on May 5th, 2022 and by June 16th of the same year, the markets would see the country's highest interest rate hike in 28 years. June's interest rate hike of 75 basis points not only reminded market participants of macro economic concepts such as 'demand destruction' and 'stagflation', it was also followed by another three consecutive 75 basis point hikes in the months of July, September and November. This means that by the end of November 2022 the Federal Reserve's fund rate was at 4.00%, all the way up from a measly 0.25% prior to the commencement of this particular interest rate hiking cycle. In the month of June 2022 Consumer Price Inflation in the United States hit 40-year highs expanding at an annual rate of 9.1%. Since then it has slowed, increasing at just 4.9% per annum in April 2023 for its slowest expansion since October 2021 according to Michael Kramer writing for Investing.com.

Diligent market observers will of course be quick to point out that the Federal Reserve was late in commencing its interest rate hiking cycle unlike the European Central Bank which started raising interest rates in July 2021 already. This would then explain the Federal Reserve's aggressiveness, it had some catching up to do. Be that as it may, the markets were now seeing the world's leading economy by GDP fall into a technical recession with both the Biden administration and Jerome Powell insisting that there was no recession. All this after a meeting of central bank heads in Sintra, Portugal where the Federal Reserve chief appeared determined to fight inflation going as far as alluding to, in his commentary, getting supply to catch up to demand in part explanation of the Federal Reserve's aggressive stance when it came to interest rate hikes.

The Bank of England on the other hand commenced their most recent interest rate hiking cycle in December 2021, working from a historically low base range of 0.1% - 0.25%. From then onwards the bank hiked interest rates consecutively over 12 meetings at the time of writing this memo. By October 2022 the country was seeing the highest recorded inflation in 41 years at an estimated 11.1%, driven in large part by increasing food, transport and energy prices. In one of his speeches, the Bank of England governor, Andrew Bailey, is reported to have stated that inflation in the United Kingdom was being fueled by "second-round effects" that would prove sticky, perhaps alluding to further interest rate hike increases before the end of 2023.

On the local front, the South African Reserve Bank governor, Lesetja Kganyago, is recorded by Business Day as affirming the latest inflation forecast. From his statements, it would appear that annual consumer price inflation has remained stubbornly high in the country since peaking at an apparent 13 year high of 7.8% in July 2022. This was up from 7.4% in June of the same year. In their May 2023 meeting the reserve bank lifted the repo rate by 50 basis points to 8.25% in what was apparently a unanimous decision by the bank's monetary policy committee. This increase is recorded as the 10th consecutive interest rate hike by the South African reserve bank in the most recent cycle.

There is ofcourse a view which insists that the South African reserve bank should continue hiking interest rates in order to avoid stagflation - a situation where inflation gets out of the bank's target range of between 3% - 6% mixed with low economic growth and high unemployment. One should perhaps remember that the South African reserve bank's inflation target is apparently set in consultation with the country's government and that the reserve bank should have full operational independence. Others might argue that the recent interest rate increases have done nothing more than present domestic households with increased financial pain. This adds to already heightened levels of uncertainty as a result of the country's persistent loadshedding.

The Rand's recent record lows against the U.S. dollar have not come to the aid of the local micro-economic situation with FNB Wealth and Investment's Wayne McCurrie describing the recent price action between the two currencies as normal behaviour on the part of the Rand. He goes further to point out how the local currency acted in a similar fashion against the greenback during the Dot-com bubble of the late 1990s, the 2007 - 2008 global financial crisis and again after Nhlanhla Nene's December 2015 axing as South Africa's finance minister. One analyst even points to how the Rand's weakness against the dollar would have been much worse for the local unit had it not been for the South African Reserve Bank's prompt and consistent action in taming high inflation. According to Thamsanqa Neta of Shiloh Capital, the South African Rand is the most liquid of all emerging market currencies which partly explains why forex traders have a keen interest in the currency's price action especially against the currencies of major global economies.

Some analysts have also observed that in South Africa, persistent load shedding has been the leading contributor to demand destruction. This is in contrast to the rest of the global economy where the destruction has been spurred on by record high inflation. According to a May 12th, 2023 article written by Kristin Engel for IOL, in just more than four months the country has already had more power cuts than the whole of 2022. The global inflation picture got to a point where the June 2022 U.S. CPI print triggered a bear market in both growth and tech stocks in what is described as a 'holdover' from the covid-19 pandemic as investors attempt to determine the long-term effects of the pandemic on the global economy. In his June 27th, 2022 commodities outlook article for Investing.com, Barani Krishnan noted that the Federal Reserve was on a fast track to neutral by the end of 2022. 'Neutral' is Fed talk for bringing interest rates to parity with inflation in an attempt to stop price pressures from going any higher. He further observed that the Federal Reserve had intentions of selling government bonds that were in its hold in order to bring down inflation even faster in what is referred to as open market operations.

Amongst all the turmoil brought about by sticky inflation, the Bank of Japan surprisingly continued to keep interest rates low going against the trend of the majority of global central banks. By the time reports of the Yen's weakness against the dollar came out, the currency had hit a fresh 24-year low against the dollar. This was due to the bank's insistence on sticking to its policy of ultra-low interest rates in supporting the country's economic recovery albeit there were concerns over how the plummeting currency could impact the country's business environment. Continuing with the theme of going against the grain when it comes to interest rate hikes, Turkey continued with their own policy of cutting interest rates further adding to the country's high and rampant levels of inflation. All this in the same global macro-economic environment which saw the Swedish central bank, for the first time in its history, raise interest rates by 100 basis points.

In this current environment of high and sticky inflation, the markets also observed what we at Requisite Small Business Advisory refer to as 'liquidity moves'. A case in point would be Porsche's (PAH3:DE) Initial Public Offering which made the luxury brand a stand alone entity from parent company Volkswagen (VOW3:DE). The separation was meant to boost VW's liquidity as the company now apparently faces major challenges with the most notable one being digitisation. In a similar fashion the markets would also see Pick 'n Pay, for the first time in the grocery counter's history, listing on the A2X as from November 1st, 2022. This means that the local retailer would still maintain its primary listing on the JSE and according to current Chairman of Pick 'n Pay holdings, Gareth Ackerman, shareholders would benefit from increased liquidity, cost savings incurred from narrower spreads combined with the cheaper trading platform. Over the same period market observers also saw Meta (NASDAQ:META) letting go of 11 000 staff members, equivalent to 13% of the company's workforce in its own attempt at maintaining high liquidity by reducing a notable semi-variable cost.

Besides sticky inflation, the rise of the dollar has also been one of the dominant themes of 2022 going into 2023 with the Federal Reserve's rapid interest rate hikes providing the dollar index with an apparent edge over its peers. The dollar index is a measure of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of the United States' trade partners' currencies which include the Euro (EUR), Japanese Yen (JPY), Pound Sterling (GBP), Canadian Dollar (CAD), Swedish Krona (SEK) and the Swiss Franc (CHF). As a counter trade to the U.S. dollar, some analysts will argue that the reason gold gets down trodden after each blockbuster CPI report - like the one we saw in June 2022 showing annual U.S. inflation rising to a new four-decade high of 9.1% - is because of the interest rate expectations that such reports bring. Higher interest rates tend to place immense pressure on metal prices by increasing the opportunity cost of holding non-yielding assets. This is part of the reason why we saw gold dropping from record highs of about $2070 per ounce in February 2022 all the way down to $1617 per ounce in September of the same year. These interest rate hike expectations will also tend to cause the dollar and treasury yields to rally upwards as the two main contra trades to gold.

The July 2022 Non Farm Payrolls data has not helped matters either when it comes to the most recent cycle's inflation outlook. The data confirmed an additional 528K jobs versus economists' expectations for an increase of just only 250K. It would appear that the real challenge with the strong job numbers is the pressure it brings on wages. This has apparently prompted a change in consensus among money market traders leading the majority to believe that the Federal Reserve will be more hawkish in hiking interest rates even further. Financial Analysts such as Duma Gqubule argue against interest rate hikes, especially in the South African context, explaining - in an interview with Rams Mabote - how useless interest rate hikes are especially when inflation is driven by the supply side. Adam Tooze, director of the European Institute at Columbia University, goes even further in describing interest rate hikes calling them 'austerity' by another name. Recent data-driven evidence suggests that core CPI remains stubbornly high, way above the Federal Reserve's target of 2%, suggesting that more interest rate hikes may be on the cards heading into 2024. If we are indeed at the tail-end of this current interest rate hike cycle which would suggest discounting any further rate hikes, then the likelihood that the Fed keeps interest rates elevated for longer seemingly remains strong.

At the time of writing, the Federal Reserve had raised interest rates 11 times between February 2022 and July 2023. This means that the central bank has now added a total of 5.25 percentage points to its fund rate and as mentioned earlier this is from a base rate of just 0.25%. From a recent press conference it has become clear that Jerome Powell's new main concern has now become energy-driven inflation. Writing for Investing.com, Barani Krishnan quotes Powell as saying; "We are prepared to raise rates further, if appropriate. The fact that we decided to maintain the policy rate at this meeting (that of September 20, 2023) doesn't mean we have decided that we have or have not at this time reached that stance of monetary policy that we are seeking". If the Federal Reserve remains committed to achieving its annual inflation target of 2% then it has no choice but to remain hawkish when it comes to interest rate hikes even if this means dampening the outlook for global growth and possibly making the risk of a global recession more tangible. If OPEC+ were to somehow agree to put a lid on oil prices in order to assist the world economy avoid a likely recession looks like a good story for another day.