<img alt="" src="https://secure.inventiveinspired7.com/792353.png" style="display:none;">
post-image

Relief, Euphoria and Yet Crying

  • US inflation is not too bad…
  • …financial markets in euphoria
  • I don't think they get off that easily
  • Dutch inflation: I can only cry"

Google Translated from Dutch to English. Here is the link to the original article in Dutch. The article was originally published on 11 November 2022.

 

US inflation fell for the fourth consecutive month in October. The decline was stronger than expected. This led to gigantic movements in the financial markets. The idea behind all these moves is that inflation is apparently starting to come under control and that the Fed will therefore not have to raise rates much further. The first picture shows the effective yield on 10-year US government bonds, say the US capital market rate, over the last five days. After the publication of the inflation figures on Thursday afternoon, this interest rate quickly fell from 4.1% to 3.8%. That's a really big move.

 

In the wake of the US bond market, capital market interest rates also fell in the Netherlands, but much less sharply. Our effective yield on 10-year government bonds fell from 2.45% to 2.30%.

 

Effective yield on 10-year US government bonds

 

Source: Trading Economics

 

 

In the wake of the US bond market, capital market interest rates also fell in the Netherlands, but much less sharply. Our effective yield on 10-year government bonds fell from 2.45% to 2.30%.

 

Effective yield on 10-year US government bonds

Source: Trading Economics

 

 

The second picture shows the price of the NASDAQ. The stock markets are having a bad year because interest rates have risen so sharply and a recession may be imminent. The NASDAQ mainly lists 'growth stocks' and they are more sensitive to interest rates than other stocks. The chart shows that the NASDAQ rose as much as 7.5% after the release of the inflation figures.

 

NASDAQ

Source: Trading Economics

 

The inflation figures also had a major effect on the foreign exchange market. The prospect of lower interest rates in the US with an unchanged outlook for European interest rates pushed the euro back above parity against the dollar.

 

These are truly historic movements. The movement seems logical, but still quite large. What's going on here now? If the turning point in inflation has indeed now been passed and US inflation is now moving rapidly towards 2%, then the movement may be justifiable not only in direction but also in magnitude. But it could also be that market parties were simply extremely relieved by the figures or that all kinds of automated trading systems started to move en masse.

 

In any case, US inflation fell from 8.2% in September to 7.7% in October. Core inflation also fell slightly, although the chart shows that you cannot say that a clear decline has already started.

 

Finance4Learning | US: Inflation (% y-o-y)Source: Refinitiv Datastream

 

I don't think they get off that easily

 

I am optimistic that inflation will fall more sharply in 2023 than many expect. However, I do not yet see the October figures as a sign that the time has come. Normally, it takes a considerable cooling of the economy to significantly limit very high inflation. If US inflation were already on track towards 2%, you would have to conclude that the Americans would get off easily. I can't imagine that. And don't forget that the price level in October rose by 0.44% compared to September. If that rate is maintained for 12 months, inflation will still be around 5.5%. The fact that the year-on-year figure fell back in October was mainly because prices rose by 0.9% in October last year. So, there is a base effect.

 

Nevertheless, lower inflation is very welcome, and I think the downward trend will continue. Ultimately, sharply reduced international freight rates and reduced logistical disruptions will contribute to normalisation of prices. In the past two years many prices have risen disproportionately and then you can expect a normalisation, ie a decrease. Second-hand cars, for example, have become considerably more expensive in the last two years, but are now becoming cheaper again. In the last three months those prices have fallen by almost 7% and that seems to me to be just the beginning.

 

 

Finance4Learning | US: Prices (index Jan '18 = 100)Source: Refinitiv Datastream

 

I have often written about the importance of rents in US inflation. The story is simple. Actual home rents and rents imputed to homeowners make up about 32% of the US inflation basket (about 22% for us). And in the basket of core inflation even about 40%. Rents follow house prices in the US, albeit with a lag that varies. The rate of increase in rents increased further in October: from 6.7% in September to 6.9%. The following graph shows that the rate of increase in house prices is now falling. With some delay, the increase in rents will therefore fall. But that will only take shape in the course of 2023. When that happens, it will speed up the fall in inflation in the US.

 

 

Finance4Learning |  US: House prices and rents (% y-o-y)

 

I am crying tears

 

Dutch inflation also fell somewhat in October. According to the national benchmark from 14.5% in September to 14.3% in October. According to the European HICP benchmark, inflation in our country fell from 17.1% in September to 16.8% in October, which was published last week. Despite the drop, it still brings tears to my eyes. The comparison is undoubtedly flawed, but inflation in Brazil has been falling for months now. After a peak of 12.1% in April, inflation came to 6.5% in October, less than half of ours! Unimaginable! And that while you always associate Brazil with much higher inflation than with us.

 

 

Finance4Learning | Tears in Your Eyes: Inflation (% y-o-y)

 

 

If I still have tears left, I also dare to look at the energy prices. Then I immediately burst into tears again. I do know that the figures on our energy prices show an overestimation of the bills actually paid by households because many people still have permanent contracts, while Statistics Netherlands only looks at new contracts. As families run out of their permanent contracts, this naturally corrects itself. Statistics Netherlands is working on an alternative calculation method. As the figures are now in the books, the price increase of energy in our country is 100%, in Germany 43% and in the US 18%. What have we done wrong, what have we done to deserve this?

 

Finance4Learning | Inflation - energy (% y-o-y)

 

Closing

 

This week's macro news is dominated by the US inflation data because it has caused such a huge movement in financial markets. I have been optimistic for some time that inflation will fall faster next year than many predict. So, do the recent US numbers prove me right? Only in part. A reduction in logistical disruptions and lower freight rates contributed to declining inflation in October. But my optimism about next year is partly based on the expectation that a recession will occur. If this is not the case, I don't think we will go to 2% very quickly.

 

I can only cry about the Dutch inflation. Not only is it insanely high, but a comparison with other countries also suggests that our inflation is unnecessarily high. Isn't it about time policymakers subjected themselves to some self-critical reflection?

 

Oh yes, the international economic climate does not cheer me up. Chinese and Korean trade figures suggest that global trade is currently under considerable pressure.

 

And oh yes, inflation in Russia continues to fall. It was almost 18% in April and has since fallen in a straight line to 12.6%. Not that I would rather live in Russia, but it does make one think.