The guest commentary below was written by written by Daniel Lacalle. This piece does not necessarily reflect the opinions of Hedgeye.
For the first time in decades, central banks are tightening their monetary policy while governments continue to spend money as if nothing has changed.
Large enterprises are not harmed by the most recent rate increases as long as credit conditions are still lax. However, households and small enterprises are bearing the full weight of the financial squeeze.
The current level of mortgage rates in the US is the highest since 2008. According to Reuters, the average interest rate for a 30-year mortgage hit 6.02% last week.
A perfect storm of declining sales and increased finance costs hurts small enterprises. While retail sales rose 0.3% in August, the data for July was corrected to indicate a 0.4% decline in sales. In addition, after July’s numbers were negatively revised, core retail sales were unchanged in August. This indicates a sharp decline in sales in real terms. Since official retail sales aren’t inflation-adjusted, August’s 9.1% increase over the prior year was actually flat.
In order to combat inflation, the Federal Reserve has raised interest rates and moderated liquidity requirements, which continue to have an impact on consumers but have no appreciable effect on government expenditure.
Government expenditure continues despite the Federal Reserve’s excessive lag.
For seventeen months, inflation has exceeded the Federal Reserve’s target, and increased expenditure by the government only fuels the fire. Core inflation continues to rise.
When the money supply is completely absorbed by new government debt and public deficit spending is kept at record high levels, rate increases are insufficient. Because of this, yearly inflation is still at a three-decade high of 8.3%. Furthermore, core CPI, which strips out food and energy, rose to 6.3% in August. This month-over-month growth of 0.6% exceeded economists’ predictions by a factor of two.
According to analysts, inflation is decreasing and, based on consensus projections, will reach 4% or less in 2023. But if all goes according to plan, that means that in two years, consumers and businesses will see cumulative inflation of at least 12%.
Also keep in mind that since March, shipping rates and commodity prices have corrected, which brings us to these poor August numbers.
Because stocks and bonds are declining, market participants are pleading with central banks to change course. An investor base that has not seen tight monetary policies in more than ten years becomes more worried. Governments are also growing more concerned about rising public debt yields.
Governments like low rates because they profit from both, even if inflation surges.
A stagflation like to the 1970s is considerably more likely if central banks alter their approach and stop raising interest rates while governments implement so-called “anti-inflation measures” that entail increasing debt, expenditure, and currency creation.
There isn’t a magic bullet for inflation. It is quite simple to start and extremely challenging to stop. Governments will continue to introduce new aid initiatives that fuel inflationary pressures if they have a financial motive to grow their debt.
The notion of cost-push inflation is disproved by rising core inflation. The majority of goods and services would see flat or declining pricing if the amount of money remained constant. If there are not more currency units available, then costs do not increase uniformly.
Those who predict a decline in inflation are referring to the rate of price increases rather than a decrease in overall costs. Not that prices would decrease, but rather that the annual rate of price increases will slow down.
Because margins are shrinking and real incomes are declining, this new reality of enduringly high prices is difficult for businesses and families to accept.
The reality that households and small companies are getting poorer and the middle class is being destroyed is true whether you are bullish or bearish on the rate of change of prices.
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinions of Hedgeye.