Monetary Policy Around The World

Monetary Policy Around The World 

Today, I'm going to briefly comment on a few monetary policies that I find interesting for various reasons. Either they've done something different or there's some abnormal idea that comes from their situation.

Including: Brazil 1, Canada 6, Japan 2, Poland 4, Switzerland 3, & The United States 5.

And some global commentary & energy comments.

***SARCASM WARNING!!!***

Brazil

Brazil is a *fun* one... they went way overboard with their hiking (in my opinion) and took real interest rates to nearly 10%... yes... that's 10%... REAL. That said, the leverage in their economy is fairly low vs many more developed markets. Still you saw the ripples globally when international companies like Nutrien essentially said it makes no sense to invest in retail in Brazil because the immense cost of working capital destroyed their margins.

But look, with Brazil's history of inflation, I can understand why they panicked with such extreme hikes. I don't think it was necessary or helpful to the people of Brazil. It has probably been a factor in the sustained strength of the Brazilian currency.

Now however, inflation has rebounded on a year over year basis back above their target, with the last half year would be well below.... Despite this rebound in headlines, they're easing. They've now cut their interest rate by 100 bps in the last 2 meetings (50 each). It's still insanely high at 12.75% vs 4.6% headline inflation. (Heading towards 5 on base effects) Headline will probably be in the 2s or 3s in a few months. I think rates need to fall by at least +600 bps to be reasonable and they'll probably fall by +800. The high cost of capital is a hindrance to local businesses and favors large international players with cheaper money who can undercut locals due to better financing terms.

It's a weird mix of early panic unlike much of the world... and now, even thought inflation is higher than Canada for example, they're more aggressively easing why we all freak out about similar misses to targets. (Literally about to see 5 vs 2-4 target vs Canada at 4 vs 1-3 target)

Japan

Ah yes Japan... the answer to the question of, "Whose data should we ignore to keep pretending that the old thinking makes sense?"

Japan didn't raise rates at all in the face of inflation... so by everything I've ever heard, people should be borrowing money at real negative rates to spend... inflation should be accelerating and sticky etc.

Well, it's fallen from 4.5% to 3.2%... despite the currency taking a monumental beatdown. I could make the argument that if the rest of the world hadn't jacked up rates (potentially needlessly) and Japan's currency hadn't been slaughtered, their inflation would probably be even lower... by that line of thought, rate hikes may not actually bring down inflation. All the inflation comes from foreign rate hikes hitting the currency. So if they didn't need rate hikes to tame inflation... what if others didn't... and didn't hike. Then you'd have this bizarre 'impossible' scenario where inflation falls everywhere without anyone hiking. To the "that's impossible, it's not how inflation works" argument that some are certainly thinking... check out what happened after the second world war... exactly that.

Sure it's still above target and higher than in many years. As I mentioned, that's probably partially on the currency. Another element that's almost comical is that Japan is actually stimulating their economy!!!

A point I made long ago is that if cost of living goes up more than incomes... the increase in cost of living isn't sustainable. Higher prices would revert. Japan on the other hand... it TRYING to make their inflation sticky. So they're trying to have their stimulus offset the unaffordability of increased prices... to try to make their inflation stickier. Still, inflation is cooling. The multi-month trend is something like 2.4% annualized... despite the murder of the YEN, lack of hikes and the stimulus. More than 2/3 of their inflation is food (which has global prices and has recently been slowing). Tokyo Core CPI has declined to 2.8% YoY... Not "Solved"... but enough to confuse A LOT of people.

On the subject of sustainability, that's why I was adamant that a lot of the inflation we were seeing would abate (be transitory). The causes were one off factors almost across the board. The stimulus, the supply chain, the prices going from desperate seller to incentivizing supply. the rate of change on none of those was sustainable... not at 0% interest rates or 15% interest rates. Stop paying people to not provide supply, fix supply chains, let incentive prices bring on supply, let the tech companies layoff labor to rebalance with the other sectors and the inflation virtually stops. If something isn't sustainable... it won't sustain. Some countries panicked... and raised the cost of production (making some of the inflation stickier than it needed to be... others didn't)

But here's the distinction that western economists cling to... unemployment. It MUST be that Japan has enough slack in the labor force that wages aren't a problem for cost push inflation and rising prices. Yes, it must be because... Their... ummm... 2.7% unemployment rate provides ample slack.

But let's just go on believing that you NEED to raise rates to bring down inflation. You NEED less people employed to stop it too.

Switzerland

Switzerland, the debt capital of the world apparently, didn't 'need' raise rates much. They only took interest rates to 1.75% and inflation is back down to 1.7% from a near 3.5% peak. Ok...

In a bizarre fact for the "well people would just borrow to keep spending theory" Swiss inflation peaked while interest rates were still negative.

It's almost like low interest rates prevent inflation. (Obviously that's not correct and there are numerous other factors... but if you look at supply and demand from the bottom up, there's something to this.)

It wouldn't surprise me if they're back to 0 rates and fighting deflation again in a few years. It also seems difficult to get there.

In an inexplicable turn of events to the "interest rate differentials drive currencies" crowd, despite this lagging on rates vs the rest of the world, the Swiss Franc has been too strong if anything... yeah, I don't know. I guess maybe, just maybe, you don't need to murder your own economy to save your currency.

Poland 

Poland made headlines a few weeks ago by making a later than expected rate cut despite headline inflation being a whopping 10% YoY!!!

That seems insane until you realize that over the last 4 months their combined inflation rate was -0.2% (-0.6% annualized). 

The currency did take a hit on the surprise scale of the cut. That's gotta be expected as markets react to news. What I'm curious about is if it means persistent bleeding or if that was a one-off readjusting to policy. I think many places think they're locked into bleeding out their economy because if they don't inflation will persist via the currency. That's... in my mind the only rational reason some places can even consider more hikes at this point. If a early actor... (Poland) can disprove that it would be good to know globally.

Hence, I'm instantly rooting for Poland.

This was particularly interesting due to the high headline number and the fact that interest rates remain well below it. My belief is that the rolling off of high comps will make headline inflation fall despite the easing. What I don't know is if it will fall to 0, negative, 2, 4... whatever. It is very likely that it'll look much more reasonable... and it may be fun to poke fun at traditional thinking about what central banks need to do in order to tame inflation as inflation falls along side rate cuts after real rates were never even positive to boot.

United States

The US's mix of high debt and high duration mortgages makes them positioned differently from the rest of the world. Higher rates are passing money from the have nots to the haves. Interest on government debt is helping stimulate the economy to counteract some of the higher rates. Mortgages aren't resetting at higher rates so new slowing is only on incremental mortgages.

I do think that they're still feeling negative effects of higher rates. The term risk is heavier on the banking sector, and the banking sector is the transmission mechanism for money through the real economy. They're also not immune to changes in global demand.

Inflation measures are so obviously lagged that it's a bit of a joke to look at headline numbers. It missed the entire down cycle in rents/OER while still catching up to the last up cycle. The largest component in CPI is only now essentially caught up. Where it does next, I don't know but the momentum has cooled well beyond what is currently measured in CPI. It may still be moving higher as a category but much slower because changes in the situation aren't amplified by broken supply chains and stimulus.

One thing that has seen only minor discussion in passing is the MASSIVE surge in capex in the United states. Capex is short term inflationary, long term deflationary... It takes a lot of money, spending and labor to build something, then less labor to add supply which pushed XYZ prices down as the cost of the plant is paid off. So as that capex becomes opex, it's another headwind to inflation.

I think inflation is heading lower to the mid 2s probably. I think that would and should be enough to stop hiking. We'll probably have to watch from there. I think there's strong underlying demand but with the pressure on the banks from the bond market, prices are now effectively so high for anything that needs to be financed that demand is being deferred.

I think stability on the rate front and time would allow mortgage spreads to come down making even these rates less cumbersome. 

Canada

Most of my other pieces reflect on the BoC so I'll try to be brief.

All our problems are self induced stupidity. 

Trying to satisfy a 1.2M population growth with 250k housing units because we keep attacking our housing development & affordability with rate hikes is beyond insane. That's WHY our rent inflation has started exceeding the US.

The top 2 causes for inflation are what we do to fight inflation, so we're hoping to break other things to more than offset the damage we're doing with our actions. It flies in the face of logic and bottom up economics.

Why? Because people seem to think it's the only thing we can do... I'd think "if you're in a hole, the first thing to do is stop digging" but what do I know.

We should have stopped hiking 8 months ago... we'd have more housing supply & less rent inflation... less mortgage interest cost inflation. If we had food that was in line with global averages at the same time (instead of our Canadian supply management + carbon tax special) that would be another 0.5% off inflation taking us to a very reasonable roughly 2.7%. (4.0 - some food, MIC & rent). I'm sure some would argue that those are causing price reductions elsewhere... I mean that's not what's happening in the rest of the world... but hey if it fits conventional economic theory... let's go with that.

You know, if your goal is to reduce sales volume by killing demand... that also requires sellers to get higher prices to operate... But that's another can of worms.

But... because we've committed to absurdity as a policy... it looks like we're going to hike at least one more time. More developed projects shelved to help rent inflation.👍

Globally

Reshoring was an interesting story coming out of COVID. I think some of the deflation we're seeing out of China comes from the slower growth and overcapacity from supply chains shifting elsewhere. I don't know where China goes from here but remaining overbuilt with a declining population has me questioning what their economy can do. Even a highly managed economy and currency may have trouble with such a large pivot.

I think this is what's causing the big boom in Mexico and US-Mexico trade. With labor tighter in the US "as the narrative goes" Unions are trying to exert their force. Honestly, the ask on this UAW stuff reads "fire us and go to Mexico but I think they may be not quite seeing that as it often seems like professional socialists (unions and further left political parties, have this amazing hole in understandings of economics... or at least pretend to.

Energy Crisis

Some would suggest that an energy crisis will lead to sustained inflation. There could be one which could prolong inflation. I don't believe there has to be one or that it'll inevitably lead to prolonged stagflation. Many places can produce a lot more at $80-90. Canada can add a bunch next year when new pipes come on. People might argue that no one will do crude by rail due to the increased cost. Crude by rail is currently 100kbbl/d down from 400k/d. I'm just going to say that if someone thinks oil will spend any extended time at +120 and Canadian producers won't ship crude by rail because of a $15 discount, I'll take the other side of that bet. Similarly, I know people argue that demand is inelastic but on the margin that's nonsense. Oh, I didn't even get to Brazil or Africa when talking about supply growth potential. Price and time solve this, at some prices there are unsolvable deficits. At other prices there are unsolvable gluts. Meanwhile, recently we've seen Crack Spreads normalize for gasoline... Finally. So yeah, if someone decides to really break S/D there could be an issue. Absent something extreme, we don't need much more energy contribution to inflation before a lot more production can start progressing.

Was I Wrong?

Was I Wrong about inflation being transitory? Yes & No. I mean we've seen in both places that jacked up rates like crazy & places that didn't, inflation come down quickly without too much stickiness. It's also lasted much longer at above target levels than I was thinking. Even now, we've fallen lower and further than the 70s (what some of the sticky crowd feared). I think we could have handled so many things better. If you recall I was critical years ago that they kept blasting QE wayyyy too long. I was also bullish on inflation back when we were handing out cheques & commodity prices were too low. So I guess I'll admit to not predicting the second wave (the war) but even with that or absent that, I think we'd have been even more transitory than the mostly transitory that we got. I also missed the impact of broken supply chains and the second wave of COVID in China.

I was early also in suggesting that rate hikes wouldn't help (which will always be debatable either way). Slowing supply doesn't fix a supply shortfall. Not in Lumber, Steel, Energy, Housing, you name it.

That said, one thing I absolutely got wrong is that rates got here. I still think there's no reason for them to be this high and that they aren't particularly helpful on the inflation front. I thought we may get to 2.5 or 3 percent but am shocked at where we got and still not definitively stopped.

END

How naïve I used to be... thinking that investing was all about buying a good company at a good price. In truth, a good company at a good price can be a terrible company at a terrible price when the people in control of the decisions above triple interest rates to force a needless recession. So much is so arbitrary, so often.

I leave you with a question. Is economics a science, a pseudoscience, or a giant appeal to authority?

Disclaimer: This is not investment advice