May 13, 2022 | 13:00
From Transitory to Tenacious
The road ahead is long and treacherous, replete with plenty of potential deep disappointments, the occasional rush of relief, but unquestionably fraught with serious danger and possibly ending in devastating heartache. And, no we are not talking about the Maple Leafs’ playoff outlook—it’s bringing inflation back to home base.
This week brought a harsh reminder that there are simply no easy wins in this environment for inflation. Even with the generous helping hand of lower used car prices and a temporary lull in gasoline prices, U.S. CPI still landed on the high side of expectations in April and remained stubbornly above 8% on the headline and north of 6% on core. Germany confirmed its 7.8% pace for the same month, the highest that nation has seen since 1973. Even China reported a faster-than-expected 2.1% clip, despite a lockdown hit to growth.
Compounding the sticky April readings, energy prices are displaying some real resilience, with WTI rebounding to around US$110 by Friday, and natural gas holding near $8. And, product prices are flaring even more vigorously—notably diesel—amid a refinery squeeze and falling Russian exports. Grain prices are also weighing in; after a brief respite, wheat prices climbed again with some longer-dated contracts hitting fresh record highs on a dire outlook for this year’s global crop. Note that U.S. grocery prices were already up 10.8% y/y last month.
The mounting unease about the inflation challenge ahead undercut markets broadly. Prior to a late-week bounce, the S&P 500 had been approaching unofficial bear territory, while the TSX completed a quick 10% correction from its late-March peak. Upstart crypto markets even got into the act, with so-called stablecoins proving to be anything but, while Bitcoin acted like a high-beta meme stock. As one wag suggested, cryptocurrencies have proved to be mostly a hedge against getting rich in 2022.
Notably, bonds actually moved in the opposite direction of risk assets this week—a big change from most of this tough year. In a bullish flattening move, 10-year Treasury yields fell more than 20 bps to well below 3%, while 2s dipped by roughly 10 bps (albeit keeping the 2s10s spread at around 30 bps). The moderately good news here for investors is that we may have passed maximum bearishness for Treasuries, dependent on how inflation unfolds in the months ahead, of course. We suspect that U.S. inflation is likely to slowly grind lower over the next year—assuming no further spike in oil prices—but with the emphasis on “slow”. To be clear, we remain well above the consensus on the inflation outlook: we are expecting headline inflation to average 7.8% this year and 4.0% next, while consensus is now 7.2% and 3.3%.
Attention will turn to Canada’s April CPI report in the coming week. Unlike the U.S. figures, Canada did not have the used car spike a year ago, so the base effects are less friendly. In that vein, we believe that the apex for headline inflation still lies ahead, expected to push above 7% through the spring. That threshold may not be breached next week (we are calling for a 6.8% rate), but it now seems like only a matter of time. Suffice it to say that this is already far above the Bank of Canada’s latest forecast (released less than one month ago). Deputy Governor Gravelle “humbly” allowed in a speech this week that their projections were going to rise again—the MPR had an average inflation rate of 5.8% in Q2 (we believe it will be above 7%) and 4.5% by Q4 (we think 6.5%). As in the U.S., we are loud and proud in our top-of-consensus forecasts for inflation this year and next. Indeed, the bigger concern is that even we are still underestimating the tenacity of inflation.
Faithful readers of this space, yes both of you, will be well aware that we are no shrinking violets when it comes to holding the Bank of Canada’s feet to the fire on policy decisions and communications. This is always in the spirit of trying to foster even better decision-making in Ottawa, by adding some Bay Street perspective, and offering some pointed comments when necessary. So, it’s a little unnatural for us to defend the Bank (which can do a perfectly good job on its own on that front), but here goes…
We recognize that these remarks can be seen as a highly predictable response from an “elite seat”, and/or possibly from someone defending their turf on BoC critiques from an interloper. But we also don’t want to be witness to a messy modern-day version of the 1961 Coyne affair—the one time a BoC governor left office amid a policy dispute—especially not at such a critical juncture for the economy.