Supplement 160423 – Unbelievable

Apr 15, 2023

“It’s unbelievable how much you don’t know about the game you’ve been playing all your life.” – Mickey Mantle, professional baseball player.


Welcome to the Supplement – always a piecemeal week after a Bank Holiday, no matter how much that brief rest was needed, and school holidays always offer a mixture of pros and cons on the balanced scorecard of life. Traffic is always so much easier – what a pleasure – routine is always so much harder for those of us with school-aged children! Nevertheless, the opportunity to take a break is always appreciated and hopefully will have invigorated some of the readers of the supplement!


Last week I offered up some reflections about efficiency, after talking through the developing interest rate and inflation situation. This week I’ve had a couple of really unbelievable – briefly, anyway – moments and thought it would be good to share my take on at least one of them! There is also a method in my madness – as usual, hopefully – and I hope to give you some frameworks to make you better decision makers. I also have to also ask the question “cui bono” (who benefits) to my thought processes this week, whilst attempting not to don a tin foil hat, which is so often reached for in the world these days, particularly since Covid when many Governments have abused their trust and positions as arbiters and definers of “the truth” (when in reality, a few single actors without agenda have frankly embarrassed entire Governments, particularly the US from what I’ve seen). 


This all started on Tuesday – Easter had passed and the press release came out – verbatim: “Ultra-low interest rates are set to return with inflation due to tumble in the near future, according to the International Monetary Fund (IMF)”.


“Strange”, I thought, because I do think the IMF in general has a reasonable handle on economic forecasting, affairs and predictions. They have made some reasonable calls over the years compared to some of the other big forecasters that I regularly hold to account for – frankly – getting much more wrong than they get right. No-one else bothers to hold them to account or seems to care that much, so maybe I am shouting into deep space, but either way, I’ll keep banging that drum.


It took about 10 minutes – very disappointing, for someone who actively practices skepticism as often as I do, day in, day out. “Did they REALLY say that?” I asked myself. Better take a look……as we go into the detail to try and establish the truth.


The IMF has published three important papers this week. They are 6 monthly updates – published every April and October. They largely do what they say on the tin, and often run to a couple of hundred pages. They are: The World Economic Outlook, The Global Financial Stability Report, and the Fiscal Monitor. 


It’s important, I think, to take in a rough summary of what all three papers ACTUALLY say, and then compare to the statement above in bold – the press release. Here are the executive summaries from the reports themselves:


  1. World Economic Outlook (WEO) – The outlook is uncertain again amid financial sector turmoil, high inflation, ongoing effects of Russia’s invasion of Ukraine, and three years of COVID. The baseline forecast is for growth to fall from 3.4 percent in 2022 to 2.8 percent in 2023, before settling at 3.0 percent in 2024. Advanced economies are expected to see an especially pronounced growth slowdown, from 2.7 percent in 2022 to 1.3 percent in 2023. In a plausible alternative scenario with further financial sector stress, global growth declines to about 2.5 percent in 2023 with advanced economy growth falling below 1 percent. Global headline inflation in the baseline is set to fall from 8.7 percent in 2022 to 7.0 percent in 2023 on the back of lower commodity prices but underlying (core) inflation is likely to decline more slowly. Inflation’s return to target is unlikely before 2025 in most cases.


  1. Global financial stability report – Financial stability risks have increased rapidly as the resilience of the global financial system has been tested by higher inflation and fragmentation risks.


  1. Fiscal Monitor – The report discusses how public finances have fluctuated with multiple shocks since the pandemic, characterized by atypical growth, inflation dynamics, and fiscal support to mitigate the shocks. The recent financial turmoil aggravated an already uncertain and complex outlook with tight financing conditions and mounting concerns for debt vulnerabilities. In this volatile environment, fiscal policy should prioritise consistency with monetary policy to restore price and financial stability, while supporting the most vulnerable. Abrupt changes in financial conditions also call for fiscal restraint to tackle fiscal vulnerabilities. To that end, governments will need to give greater priority to rebuilding fiscal buffers by developing credible risk-based fiscal frameworks that promote consistent macroeconomic policies, reduce debt vulnerabilities over time, and build up the necessary room to handle future shocks.


The first two are also summarised in blog formats for those (99.99%) of people who don’t have the volition or the time to read the entire reports. The blog post on the WEO perhaps explains a little more about the press release. However, I’m going to pick out below the key quotes from the blog post as I see them, and then we can make a reasonable assessment.


  1. i) Simultaneously, the massive and synchronized tightening of monetary policy by most central banks should start to bear fruit, with inflation moving back towards targets.


  1. ii) Global inflation will fall, though more slowly than initially anticipated, from 8.7 percent last year to 7 percent this year and 4.9 percent in 2024.


iii) This year’s economic slowdown is concentrated in advanced economies, especially the euro area and the United Kingdom, where growth is expected to fall to 0.8 percent and -0.3 percent this year before rebounding to 1.4 and 1 percent respectively. 


  1. iv) inflation is much stickier than anticipated, even a few months ago. While global inflation has declined, that reflects mostly the sharp reversal in energy and food prices. But core inflation, which excludes energy and food, has not yet peaked in many countries. We expect year-end to year-end core inflation will slow to 5.1 percent this year, a sizeable upward revision of 0.6 percentage points from our January update, and well above target.


  1. v) Moreover, activity shows signs of resilience as labor markets remain very strong in most advanced economies. At this point in the tightening cycle, we would expect to see more signs of output and employment softening. Instead, our output and inflation estimates have been revised upwards for the last two quarters, suggesting stronger-than-expected aggregate demand. This may call for monetary policy to tighten further or to stay tighter for longer than currently anticipated.


  1. vi) Should we worry about the risk of an uncontrolled wage-price spiral? At this point, I remain unconvinced. Nominal wage gains continue to lag price increases, implying a decline in real wages. Somewhat paradoxically, this is happening while labor demand is very strong, with firms posting many vacancies, and while labor supply remains weak— many workers have not fully rejoined the labor force after the pandemic. This suggests real wages should increase, and I expect they will. But corporate margins have surged in recent years—this is the flip side of steeply higher prices but only modestly higher wages—and should be able to absorb much of the rising labor costs, on average. Provided inflation expectations remain well-anchored, that process should not spin out of control. It may well, however, take longer than anticipated.


vii) Our World Economic Outlook explores a scenario where banks, faced with rising funding costs and the need to act more prudently, cut down lending further. This leads to an additional 0.3 percent reduction in output this year.


Rather than line-by-line these points, I can just say – I feel particularly vindicated in my recent major position around inflation on the back of all this. The penny has dropped and the reasons I have been shouting about for months and years are being cited as the reasons behind it all. Enough back-slapping – because one thing that is evident to me there is that the IMF does NOT say inflation is “tumbling” in the near future and in the entire 206 page report, they mention the concept of ultralow rates ONCE – and only once – and that is to say that they aren’t coming back any time soon. So where does this quote come from?


Search a bit harder again and there is a second blog on the IMF website concentrating on a different part of the WEO report. Right – perhaps THIS is the one? Let’s see. Again, the major points:


  1. Real interest rates have rapidly increased recently as monetary policy has tightened in response to higher inflation. (Please note here that real interest rates are the rate of interest after inflation has been applied. Yes – they have increased rapidly – but they are still very low indeed, massively negative in most countries – e.g. UK, base rate 4.25%, CPI 10.4%, real interest rate is lower than -6%)


  1. We find that total factor productivity growth (the total amount of output produced with all factor inputs in the economy) and demographic forces, such as changes in fertility and mortality rates or time spent in retirement, are major drivers of the decline in natural rates.


  1. Government support may be difficult to withdraw, increasing public debt. As a result, so-called convenience yields—the premium paid by investors in the form of foregone interest for holding scarce, safe, and liquid government debt—may erode, raising natural rates in the process.

  2. Transitioning to a cleaner economy in a budget neutral way would tend to push global natural rates lower in the medium term, as higher energy prices (reflecting a combination of taxes and regulations) would bring down the marginal productivity of capital. However, deficit-financing of public investment in green infrastructure and subsidies could potentially offset and even reverse this result.

  3. Deglobalization forces could intensify, leading to both trade and financial fragmentation, and bringing the natural rate up in advanced economies and down in emerging market economies.


  1. Overall, our analysis suggests that recent increases in real interest rates are likely to be temporary. When inflation is brought back under control, advanced economies’ central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels. How close to those levels will depend on whether alternative scenarios involving persistently higher government debt and deficits, or financial fragmentation materialise.


I don’t necessarily agree with all of that – particularly point d) which for me proves just how political an organisation the IMF can be. They HAVE to say that, but the evidence at this stage does not point, for me, to that being the most likely outcome of the current and developing energy crisis of the 2020s where the price of energy hampers productivity worldwide. c) and e) do sound much more likely and both increase rates, rather than lowering them. 


That’s not the main point though. That’s the meat of the paper in terms of inflationary contributions, and NOWHERE does it say what the quote in the press said. That quote was on Sky News, the BBC, The Telegraph, The Times, The Guardian, and was remarkably similar across the board. 


So – perhaps no news to many readers. False reporting in the media. It could just be lazy – none of those journalists have read the reports. Few will even have bothered to read the blogs. Onto the next question – Why? Just Why?


That gets quickly to “cui bono” – who benefits from this? This is nasty stuff, in my view. There’s (anecdotally, granted) a metric ton of homeowners at the moment waiting for rates to go down. A headline like that will cheer them along – yes, it’s only temporary. Where have we heard that before…….? Do the government want to calm down the unhappy homeowners who are facing massive bumps in their mortgages as their fixed rates expire? Just to keep voters happy? Something else? Answers on a postcard please! (or in a comment)


Well, we’ve heard it a bunch of times. One of the more recent ones was when this period of inflation was “transitory” according to all the central banks. Rarely do you hear such hogwash – although arguably, even if the CBs did not think it was transitory, they probably had to say that (although their actions could have been different). 


These higher rates are transitory, then? Not in my view. There are rough rides to come – the recent banking wobble in the USA, with some contagion into Europe, being an example of one. However, the core inflation problem remains, and with the figures in the US this week showing CPI down but core inflation (stripping out volatile food and energy prices) ticking back upwards, and only being 0.3% below where it was a whole 12 months ago (and with the UK having even HIGHER core inflation than the US, at 6.4%) – how transitory is transitory?


In reality we need a negative event to send rates back down. Something even more key than inflation – something that threatens financial stability with significant negative connotations for everyone in the economy. No-one wants that! It isn’t a good outcome for many other reasons (will tenants be able to pay their rents, for example!). 


I’ve said it before but am more comfortable framing things in tighter terms these days. There IS a likely “tumble” in inflation coming – from 10% down to 6% or so. That range between target (2%) and 6% is likely, in my view, to go on for AT LEAST TWO YEARS after the 6% has been hit. This is simply based on economic history and how hard it is to control inflation once the core has “gone”. 


That isn’t an environment that can see lower rates in any particularly short order. That leads to a very simple conclusion. 


Don’t sit and wait for rates to get better. If things are not working now, take action now. Repurpose assets. Reorganise assets. Optimise assets. Actively asset manage the properties. Sell them if you have no other option. Sitting and waiting whilst cashflow is negative could seriously damage your wealth if the bigger forecasters are correct and prices are going to take a 10%+ tumble (I really don’t see that coming, by the way, black swans aside – personally I am a lot more bullish on prices than that, mostly thanks to ongoing inflation as discussed!)


If I’m wrong, and rates drop dramatically – what a win you’ve had anyway. The 7+ year fixes will be out in force at that point, and I’ll be very happy about it! I just don’t think I am, though – and have 85%+ certainty in the analysis above.


More than usual I needed to take my own advice this week…….keep calm and carry on!