Macro micro trader

The writing was on the wall and the street when July inflation was reported earlier in August that it is going to be lower month on month. Nothing goes up or down in a straight line and some cooling off was in the offing, especially when you look at the way commdity basket had taken a beating from the June highs (chart below):

But what was surprising (or may be not) is that many market participants decided to label the inflation print as “the top for inflation is here”. Sure, it was a breather from the 40-year high of 9.1% to still a 40-year high of 8.8% but that alone doesn’t justify the call of peak inflation.

Also, the fact that interest rates are still way too lower compared to where inflation is, I can only laugh at those who still think inflation has been curtailed and we are heading back to the Fed’s targeted 2% print. Far from it, as far as I can see.

Let me try and paint the picture from some macro perspective. Firstly, the inflation scare that started based on transitory pandemic driven factors has now driven systemic supply constrained, demand driven sticky inflation. In a layman language, it means the supply shocks of comoodities due to pandemic related shortages and supply bottlenecks, was also accompanied by demand from the abundence of money supply that the authorities poured into the system since the GFC (2008 Financial crisis) and even with much more force during the pandemic.

What happens when one entire generation of population has been habituated of easy and free money at almost no cost to them, is now being told the money they have been using is not free anymore, is not cheap at all and on top of that it would cost even more? You guessed it right, withdrawal symptoms akin to a drug addict are bound to occur. Since last fourteen years almost entire world has been getting money supply at near ZERO percent rate, are habituated to use that money on an ongoing basis all these years and now can not do without it. It would take painstakingly difficult and months and months of efforts for them to be able to NOT use the money at the same ease and speed.

That’s just the demand side of it. Demand driven by years of habits of using money as they wished. Demand, that is now difficult to get rid of. If you do, the pain would be seen on the streets and surely on the polling booth when the voters show their angst by voting against the ruling administration.

And what happens when you add the supply side to the story? We all have heard, read and firsthand experienced various shortages over the last 12-24 months of many key commodities and components, chips, one key compnent that is largely used in almost all the electronic goods had driven cost of many good at skyrocketing prices, inclduing used cars and mobile phones. If that was not enough we had war shock from Russa on Ukraine that drove energy prices over the roof. As a result entire Europe is now paying 10 times higher prices for their energy bills. Stories of people protesting on the roads are now all over the internet. If you haven’t read them, here are a few: UK (Protests Against Soaring Energy Bills Spread Through UK, and CEOs Are Taking Notice – Bloomberg), striking workers in France, Spain and Belgium (Analysis: Heat or eat? Winter protests loom as energy poverty sweeps Europe – Reuters), Ecuador, Germany, Hungary (Skyrocketing Global Fuel Prices Threaten Livelihoods and Social Stability – NY Times), Bangladesh (Bangladesh cuts school and office hours due to soaring energy prices – France 24).

While, these protests would make authorities act faster, but only if you could treat a patient in a day for the sickness that has been in the system for years! And if that wasn’t enough, what adds salt to the injury is the drought faced by many parts of the world, threatening shortages of key food items such as corn, wheat, cereals.

Here are a few articles yet again that tell us what lies ahead: China’s Fragile Economy Is Being Hammered by Driest Riverbeds Since 1865 – Bloomberg, The World’s Rivers, Canals and Reservoirs Are Turning to Dust – Bloomberg. Exacerbating the problem is when countries like India, that export key food items such as whet are now turning into importers: India May Import Wheat in Blow to Modi Goal of Feeding World – Bloomberg. Its not the food alone, the cars too: Honda Says China Plant Remains Shut as Power Cuts Are Extended – Bloomberg.

When supply is constrained you need more supply to come in, but producers are reluctant to put in money due to low commodity prices of the past and unless their capital expenditure picks up, the supply side of the situation would not be contained.

The crux is – anyone who is not reading the writing on the wall (yes again), is fooling himself. There is a reason why Powell said what he said in his Jackson Hole speech (History warns against prematurely loosening policy: Powell). While, inflation has cooled off a bit, it is still at scaringly four decades high at 8.8%. If that wasn’t enough the droughts all around the world and soaring energy bills are only going to make things worse for central bankers to tame inflation.

Central bankers can only cure demand side of the situation by making money expensive, but when supply itself is constrained by drouughts and war, there is nothing that any central bank can do in it. And yet, all they have to do is raise rates above prevailing inflation print so that the demon can be perceived to be tamed and yet not be lower enough for the rates to come down.