War, commodities, inflation, bonds and equities

Earlier this year I reported that a minority of economists contended that global market participants had exaggerated fears about accelerating inflation and higher interest rates.

In the short run the war proved them wrong. Inflation, especially energy prices have soared. Long term US treasury bonds jumped to 4.2 percent. Prices of long term bonds, the inverse of yields, have tumbled.

Wall Street and other stock markets and sovereign and corporate bonds are volatile and jittery because of war worries.

Medium and longer term, however, the minority thesis holds.

Respected monetary economists, Lacy Hunt of the US treasury bond fund manager Hoisington Investment Advisors and Brendan Brown founder of Macro Hedge Advisors disagree with the economic consensus. They believe that inflation and long term bond yields are peaking.

Several economists want higher rates, despite looming recession

Well respected economists such as Larry Summers of Harvard, President Bill Clinton’s Treasury Secretary and President Barack Obama economic advisor, were right in contending that already high inflation would accelerate further and that interest rates should be hiked to counter it.

“There’s a witches brew of a tight labour market and loose monetary policy in the US,” Summers said.  

“I believe we are now driving above the speed limit. The central challenge is to achieve a gradual soft landing, and I believe that will require monetary policy substantially tighter than the Fed or the market now anticipate,” Summers opined at the American Economic Association.  

He added that “it was approaching absurdity to suggest inflation was caused by bottlenecks. Wages are rising at a 7.5 per cent annual rate.” The war, of course raised price levels.


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Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School of Business, also agreed that “a fresh surge in inflation” had made him nervous. He warned that accelerating pricing pressures could compel the Federal Reserve to raise interest rates at a faster clip than currently anticipated. Tech stocks slid and there wasa “rotation” into value shares.

Federal Reserve Chairman Jerome Powell said that high U.S. inflation could be prolonged into early 2023 because parts and material shortages might be getting worse. In their minutes on December members of the Fed board agreed that money should be tightened and hinted that interest rates should rise.

Much however, depends on commodity inflation, but economies are already beginning to slow down.

Disinflation and recession threat

Hunt of Hoisington believes that such policies are far too late in the day. US, European, Japan and China are already slowing down. Interest rate hikes would aggravate the downturn and as the year progresses inflation could turn into disinflation. If a recession occurs there could well be deflation. Hunt’s main concern is the extent of debt in the US and rest of the world.

“Historic trends and numerous scholarly studies have verified this deleterious impact of debt on economic growth,” Hunt says. “The US appears to be walking the same economic path of the Euro Area and Japan due to the growing indebtedness and shrinking real per capita growth.”

Debt, demographics and low velocity of money

Indeed the Institute of International Finance estimates that global debt amounted to US $295 trillion at the end of 2021 or a staggering 350 per cent of gross domestic product (GDP). Middle and lower income groups are weighed under by price rises that have already taken place and their commitments to pay interest and repay mortgages and other debt. A decline in the velocity of money— the rate of turnover between business and business and person to person— illustrates the debt strain on economies. US, European and Asian economies are slowing down once again. Other reasons for the probability of disinflation are the demographics of an aging population especially in Japan and China, Hunt says.

Cost inflation hurts the consumer and ultimately cuts demand. In those circumstances prices stabilise and begin to fall

Once the supply shortages that caused price jumps start to ease, competition and high inventories could force businesses to cut prices.

Brown of Macro Hedge Advisors maintains that the rate of inflation will not accelerate much further. Price increases during the two year pandemic have been an extreme shock to the economic system, he says. The bottom line is that inflation has already taken place and is a strain on the consumer and economy. Brown forecasts US inflation rate of around 8 per cent will subside later this year.

© copyright Neil Behrmann.(https://neilbehrmann.net)  A version of this article was first published in The Business Times Singapore . For other Asian and global articles try https://subscribe.sph.com.sg/publications-bt/

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