Inflation trends remained under intense scrutiny through November into early December, with investment sages all predicting that it will be the future trajectory of price increases and the central banks’ responses that will be the key market drivers during 2022.
In the US, consumer inflation is coming in at highs last seen in the 1980’s, with the latest increase in the Consumer Price Index at 6.8% on the back of significant increases in energy and food prices.
According to research done by the Fraser Institute, Canada’s inflation rate is expected to be the sixth-highest compared with 35 other developed countries. Average consumer inflation is expected to be 3.8% for the year, well ahead of the 2.8% anticipated for the other most advanced economies.
According to the IMF, the expected average inflation rates for 2021 are expected to range from 7% in Estonia to under 1% in Switzerland and Japan. The US inflation rate is expected to average 5%.
In most emerging markets, inflation is running at much higher levels, with the Brazilian and Turkish economies particularly hard hit by mounting price pressures. Brazil has responded to its double-digit consumer inflation rate by hiking official interest rates significantly. According to Trading Economics, the inflation rate in Brazil was at an 18-year high of nearly 11% in November, and it is expected to reach 12% by the end of the year.
The Brazilian central bank has hiked the rate seven times this year to 9.25%, from 2.0% in January. In early December, it shocked markets with a 150-basis point hike, indicating another hike in February. Chile has also surprised financial markets by raising its key rate by 125 bps.
Meanwhile, Turkey’s approach to inflation is defying all economic mores. Instead of raising rates to stall inflation, President Erdogan has undermined the central bank’s independence by hiring and firing governors to ensure interest rates come down and the economy can continue to grow. In November, the consumer inflation rate came in at a sky-high 21.3% – its highest level in three years.
Supply disruptions and burgeoning consumer demand are the major forces behind the worrying increase in inflation, which was initially seen by many market commentators and the central banks as transitory. But the supply constraints and associated upward pressure on prices prove more intractable than expected. So much so that the US Fed chair Jerome Powell shifted the pace of monetary policy tightening substantially in its December Federal Open Market Committee meeting after previously saying that it was time to put the word transitory out to pasture. The central bank has increased the pace of how much it will taper its bond buying activities a month and has factored in three interest rate increases next year – at the top end of market expectations before the meeting. Analysts interpreted the faster tightening as primarily targeted at ensuring inflation expectations remain under control. Powell said that supply disruptions are expected to ease next year, supporting continued gains in economic activity and employment as well as a reducing inflation.
Royal Bank of Canada CEO David McKay also weighed in on the inflation debate, warning that ‘persistent inflation’ is building – a position that is contrary to central bank forecasts and in line with other inflation doom-mongers, like economic and investment stalwarts Larry Summers, Ray Dalio and Mohamed El Erian.
US President Joe Biden responded to the acute supply pressures heading into the festive season by brokering a deal with the Port of Los Angeles to operate 24/7, seven days a week in an attempt to alleviate bottlenecks. Large retailers and courier companies have also committed to unloading in off-peak hours to make inroads into the backlog of products in the port.
Energy and food prices are leading the charge, with fears that an energy crisis may be in the offing and food products across the spectrum, including arabica beans, making significant gains.
Developments in the energy industry have dominated the news headlines since October, with steeply rising demand as economies opened up coming up against energy shortages, such as in Europe where gas prices spiralled about 500% when renewable energy supply sources ran dry during a wind-free season. Oil prices also looked en route to $100 a barrel, topping $80 as some countries had to release strategic reserves after the OPEC countries refused to bow to pressure to increase production. Recently the grouping put out its monthly estimates of demand and supply, which painted an optimistic picture of the likely impact of the Omicron virus on world demand for oil.
The energy crisis, which spread from China to California, highlighted the significant challenges in making the transition to a fossil-free energy future. In China, which has focused on reducing coal supplies to achieve its COP16 net-zero target by 2030, industries had to go offline to ease the pressure on the energy network. According to S&P Global Platts, “Since the energy crisis in October, Chinese policymakers and top power utilities have adjusted their stance on coal-fired power generation…and called for a more realistic assessment of the energy transition instead of impulsive plant closures that endanger energy security.”
Also plaguing China is the state of property giant, Evergrande, which faces a mountainous $300 billion debt and risks undermining the entire property industry. On December 10, the worst-case scenario materialized when the company went into “restricted default” because it could not pay its foreign debt repayment commitments. The Chinese government has made it clear that it will not bail out the company and expects Evergrande’s management to fast track its asset disposals to repay investors. However, the broader ramifications for the economy of the property company defaulting may see the government step in to contain the fallout.
In the US, soaring gas prices saw pressure on LNG producers to reduce exports to other parts of the world, like UK and Europe, which are still suffering gas shortages. Fracking has seen the US become the world’s largest natural gas producer. However, manufacturers blame the increasing exports for the rising natural gas prices. Senator Elizabeth Warren has also called for LNG exports to be reined in to ease the pressure on utility bills.
The outlook for the energy industry has been subject to significant change over the last couple of years as a result of the pandemic and now is no exception with the advent of the Omicron Covid-19 variant, which has already disrupted global travel but whose impact on the economy is uncertain. The general consensus is that the new variant won’t have the same devastating impact as the previous waves of infection because governments have become more adept at navigating the balance between health and economic priorities due to the pandemic.
The IMF, however, is not as optimistic and warns that the world is at risk of “sudden and steep declines in global equity prices and home values”. Its concerns are reflected in the current debate about how central banks can unwind their significant monetary stimulus programs, which have buoyed equity and house prices and contributed to inflation, without causing a financial crisis.
The US Fed began its tapering program in November, and the intention is for it to last through to mid-June next year. However, in its December meeting the decision to increase the pace was in line with market expectations and previous comments by Fed chair Jerome Powell. What impact this more hawkish stance could have on financial markets next year is unknown. However, further volatility is expected to lie ahead.
We have always advocated for investing with a long term view, looking at companies that could weather the storm of the pandemic and do well in a post-COVID-19 environment. We have avoided the short term fad investment themes and will continue to do so.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca