Let’s be honest; not that long ago investors around the world would have thought that interest rates would never go up again. Since the GFC tens of trillions of debts has been conjured up by the various governments around the world and pumped into their respective economies. The inflation needle barely moved towards 2%. But then Covid came along and the Governments, rather than just pump money into businesses and forlornly waiting for the “trickle down effect”, they pumped money directly into the veins of the consumers.
The Transitory Camp
It all may have been transitory, as the monetary inflation wore off after a period. As Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”. Milton Friedman presumed that statement to be true if the velocity of money (the number of times money turns over in the economy) remains constant. But since the GFC, money has congealed in the hands of the rich and the velocity of money has plummeted. So, the trillions of monetary expansions barely made a dint on inflation. The Transitory Camp presumed that the largesse of the Covid handouts would result in the same affect. To be fair, currently, US 30-year bonds are trading at 2.23% with the Bond market not pricing in any long-term inflation.
The Inflation Camp
Whilst the transitory camp argues the demand side of the equation, the current and on-going supply constraints are causing prices to rise. For decades, the developed economies have outsourced their manufacturing to countries with low wages, low environmental standards, and cheap capital. The US International trade deficit is running at an annualized $1 Trillion. The Covid pandemic has caused massive and continuing supply chain disruptions. “Just in time” manufacturing has turned into “just-in-case” manufacturing, causing further excess demand as inventories need to build.
Supply chains have been disrupted by the winter storms in Texas, the Suez Canal blockage, production stoppages in various countries like India, China and Vietnam, the Shanghai airport closure, the terminal closures in China and congestion in various ports around the world. Supply constraints combined with the excess liquidity has caused inflation to spike.
The inflation has forced the hand of Central Banks around the world, with the 10-year bond rate rising above zero in the Euro area countries. The Federal Funds futures rate for December 2022 suggest that interest rates will rise to 1.4%. The question, of course, is whether highly inflated asset prices around the world be maintained in the face of these rate rises.
Michael Cornips is the Managing Director and Founder of Emerald Financial.
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