Conclusion: Inflation continues to percolate within these economies and we expect additional monetary policy tightening in each country over the intermediate term. Furthermore, we expect inflation to continue to remain a headwind for many countries globally and for that to lead to slowing economic growth globally (via policy tightening).
Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences for the global economy, due to the impact of the equation highlighted below:
QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
A brief review of global economic data points highlights three very key countries’ struggles with inflation (China, India and Brazil). While the divergence between each country’s response reminds us that both inflation and monetary policy are local, analyzing them collectively allows us to derive the equation laid out above.
Let us briefly visit each country’s headlines and data points from today’s global macro run for a quick update on the global inflation front. Not surprisingly, not much has changed from a grading perspective since we originally published this piece on November 24th:
Country: China; Policy Stance: Proactive
On a relative basis, China has been particularly proactive in their fight with inflation of late, hiking interest rates twice in the last 2.5 months, raising bank’s reserve requirements, and announcing potential price controls and supply rationing in its food market. Since we last published this note, China has continued to proactively fight speculation and today’s PMI report shows early signs of success.
Manufacturing PMI (a proxy for demand) slowed in December to 53.9 vs. 55.2 prior with the Input Prices component backing off a 29-month high, coming in at 66.7 vs. 73.5 in November. Dampening some of the positive headway made in today’s report was an acceleration in Non-Manufacturing PMI to 56.5 vs. 53.2 prior, which suggests Chinese monetary policy has more tightening to do before growth has slowed enough to rein in both inflation and inflation expectations.
We continue to have conviction that growth is slowing and inflation will remain a headwind in China over the intermediate term, necessitating more tightening measures which are likely to have an incremental drag on Chinese (and therefore global) GDP growth. Chinese Central Bank Governor Zhou Xiaochuan agrees, pledging Friday to shift Chinese monetary policy to a “prudent” stance in order to tackle inflation in the New Year.
Country: Brazil; Policy Stance: Reactive
When we last published this report, Brazil’s monetary policy graded out less than favorably due to its relatively late reaction (compared to China) in fighting inflation. It appears Brazil is finally ready to shift the fight into high gear in January, after raising reserve requirements early last month. Analysis of Brazilian interest rate swaps suggests traders are betting incoming Central Bank President Alexandre Tombini will hike the benchmark Selic rate +50bps to 11.25% in his fist meeting as chief on January 18-19.
New President Dilma Rousseff, who only recently brought about widespread concern in the Brazilian bond market because of the perception that she would fail to contain inflation, is joining in on the fight, pledging to cut government spending by $15B – a sum that exceeded investor expectations. Over the weekend, she also pledged to tackle the “plague” of inflation:
“To ensure the continuation of the current economic growth cycle we need to ensure stability, especially price stability… We won’t allow under any hypothesis that this plague returns to eat away our economic tissue and hurt the poorest families.”
The hope is that she’s willing to back her rhetoric with prudent policy action, and to some extent, she’s shown signs of this of late. On the flip side, however, we see that the Brazilian Congress just approved an increase in the minimum salary – a metric that determines both the nation’s minimum wage and transfer payments. For reference, the last adjustment to the Bolsa Familia program was a +10% increase in 2009.
Given that a broad-based wage hike would augment already-robust Brazilian consumer demand, we would expect to see more monetary policy tightening and offsetting fiscal restraint elsewhere in the government’s budget over the intermediate term.
Elsewhere on the demand front, we see Brazil’s Manufacturing PMI came in at 52.4 for December, a +2.5 increase over November’s 49.9 reading. Brazil is in a setup very similar to China: while we have conviction that growth will continue to slow throughout 1H11, it is robust enough to continue providing demand-side inflationary pressures.
Brazil’s CPI (as measured by the unofficial FGV IGP-M Index) accelerated in December to +11.32% YoY driven by higher food prices that are now consuming one-third of poor Brazilian’s incomes. By comparison, the Benchmark ICPA Index accelerated to a 21-month high in November, coming in at +5.63% YoY.
Country: India; Policy Stance: Inactive; Hurtful
India continues to lag in its bout with taming inflation, opting instead for the “wait and see” approach with regard to implementing another round(s) of tightening. Having shifted from his hawkish stance (six rate hikes in 2010) to a more relaxed position, Reserve Bank of India Governor Duvvuri Subarrao has held true to his November promise that additional rate hikes are not in India’s near-term future.
That would be fine if India had inflation under control; unfortunately, the latest WPI reading of +7.5% YoY suggests India is far from achieving its target of +4-4.5% YoY inflation. It is, however, a marginal improvement nonetheless, though expecting an additional +300bps drop from here absent any further tightening would be reckless at best. Moreover, food inflation continues to plague the 828 million Indians who live on less than $2 per day at PPP, accelerating to +14.44% YoY in the second week of December.
Compounding this blatant lack of vigilance is the RBI’s decision to add fuel to the fire by buying back government bonds from Indian lenders with the intention of increasing liquidity in a cash-strapped banking system that has been struggling to meet demand for loans. In December, the RBI pumped nearly 414B rupees ($9.3B) into India’s financial system via sovereign bond purchases (a.k.a. Quantitative Easing).
Fueling speculation when inflation is running at nearly twice the target rate is not our idea of prudent monetary policy. We expect further tightening ahead, but only after inflation becomes the problem it was in 1H10. For this reason, we continue to remain bearish on Indian equities over the intermediate-term TREND. We are, however, bullish on many commodities (corn, sugar, oil, etc.) as countries like China and India look to accelerate food and energy imports to ease any supply shortages that are perpetuating rising prices in their economies.