October 2023’s ‘Higher for Longer: A Cure and a Curse’ blog requires an update to how much longer will central bankers hold interest rates at their current levels before rate cutting begins- for instance, the European Central Bank is expected to start in June.
Central Bankers and their economic advisors, along with media pundits, are monitoring the situation very closely since inflation fell from its 2022 highs of over 10%, the highest since the 1980s, to more benign levels although still elevated from a pre-pandemic and pre-Ukrainian invasion perspective.
The US January 2024 CPI reported number was 0.4% month-on-month and nearly 4% year-on-year. In the inflation-sticky UK economy the reported January CPI service figure, monitored by the Bank of England, was 6.5% y-o-y. This includes large components including the service sector and discounts to a degree more volatile food and energy prices.
Bankers and economist through monetary and fiscal policies wish to continue supporting the post-pandemic economic recovery where, combined with the war in Ukraine, caused shortages to occur and prices to rise sharply during 2022 with food and fuel prices leading the surge which caused inflation to surge. Although there is the argument that quantitative easing policies since the great financial crisis of 2007-2009 also inevitably led to inflation returning along with the huge expansion of government debt.
The concern in 2024 is that delaying reducing base rates could easily tip the world economy in to a recession, the depth of which is much speculated over. The figures released in early 2024 suggest that mid-year is more likely with perhaps the UK being first to cut before the US or Europe.
In terms of post-pandemic economic recovery, the US has been the most impressive, with India next, and the Eurozone lagging. The UK broadly has broadly flat-lined after a post-lockdown burst. China is a (real estate debt) story of its own regarding the bankrupt Evergrande Property Group, with $300 billion of debt, and with slower GDP growth, and falling living standards.
It augurs another government induced financial miracle as the country still runs a sizeable trade surplus where cash reserves may be brought to bear. Encouragingly, Japan appears to be dealing admirably so far with rising rates for a country with a high government debt/GDP ratio with the saving grace being its government indebtedness is mainly due to its own institutions and citizens.
The dilemma of when to stop raising rates, how long to hold them steady before beginning interest rate reductions is particularly nuanced due to its implications for refinancing not only commercial real estate loans but also personal loans, car financing, credit card borrowing, and mortgages or insurance premiums which are all effected by interest rate cycles, particularly that of the US Federal Reserve.
It is companies and consumers who pay the interest, fees, and premiums from their sales and salaries. Private equity participants have reported strong earnings and asset growth by owning assets involved in such lending, particularly insurance operations. (Word to the wise: roots for a 2nd GFC? No doubt regulators are on the case).
US Treasury secretary Janet Yellen has expressed concerns over commercial real estate loans which are due for refinancing in the coming months, especially those with high vacancy rates, while rates remain elevated. Private equity operators with cash from well-timed sales of other assets have been buying bargains from distressed sellers.
However, central bankers are keen to stress that they will not be rushing to cut rates too soon or quickly which would allow inflation to return to recent highs and spoil a softer landing for the economy. The same reluctance should temper further buying of real estate assets or lending to the sector where central banks by not cutting rates reduce the opportunity to refinancing at lower rates.
Central bankers will not rush to bail out any indebted institutions, except for the most system-critical institutions, if they succumb to low vacancy rates, sticky high borrowing costs, in a weakening economy. How likely that is during a critical US presential election campaign may embolden some.
Notably, banks are better capitalised since the financial crisis of 2007-2009. Pension and insurance companies are better able generate higher returns from higher rates on debt issuance which generates annuities or income for all those ‘Boomers’ now retiring. Private Equity funds have made impressive earnings and asset valuations on their insurance asset purchases since the pandemic.
As a cautionary note with the US S&P 500 index showing a price-to-earnings ratio of 23 approx. (ignoring the outperformance of super mega technology stocks) is nearly 35% overvalued from a historical perspective of 15- is a huge potential fall in value likely? However, something more dramatic than what the market is currently discounting would need to occur for a collapse of that magnitude.
A more real-world issue for inflation worries returning and turning soft landings into harder ones is the rising costs of shipping costs and associated insurance bonds due to the Houthi rebel attacks on shipping lanes through the Gulf of Eden and the Bab-El-Mandeb strait into the Red Sea.
This all adds to price pressures causing inflation to rise on globally traded goods from commodities to finished products. The route around the Cape of Good Hope in South Africa adds 10 days to vessels journeys to Europe and adds to fuel costs and environmental pollution due to more diesel burning especially if the ship needs to speed up (Euro news, 2023).
To highlight the problem Chinese operator, ‘CMA CGM became the last of the major global carriers to withdraw services from traversing the Red Sea route. The move completes the migration south of larger tonnage away from the Red Sea’ (Kuehne Nagel, 2024).
The US Navy has carried out limited missile strikes at targets in Iran and Syria with additional strikes from the UK’s Royal Air Force (CNN,2024). With naval commitments in the Eastern Mediterranean with the Israeli/Hamas conflict, Red Sea shipping lane attacks and other demands in the South and East China Seas. The US military further stretches its resources with its commitment to arming Ukrainian front-line troops with munitions against Russia.
Meanwhile, the Royal Navy’s Prince of Wales aircraft carrier has had its repairs completed and left Portsmouth and replaced the Queen Elizabeth which has had propeller issues at large NATO exercises off Norway. Better late than never but RN performance is causing blushes with top commanders with equipment reliability and lack of personnel (BBC,2024).
Some 21st century press-ganging maybe required or better still pay new recruits decent wages that makes risking life and limb for your country worth the sacrifice as filling them full of rum doesn’t work anymore.
While all European countries would be wise to increase their defence spending to at least 2% of their respective GDPs. As an unexpected conflict may cause the economic shock to unsettle everything, not just inflation, and this may arise sooner than expected if a 2nd Trump presidency baulks at their continued NATO commitments and leaves it to us to defend ourselves for the first time since World War 2. How would that work out- would Europe rise to the challenge? It’ll take more the Rheinmetall of Germany making more tanks. We’ll find out soon enough.
LDC.
Reference and Further Reading-
Higher For Longer: A Cure and a Curse. ( October 2023 blog)
BBC News, (2024), ‘HMS prince of Wales: Delayed Carrier Leaves Portsmouth’ 2024 BBC, London UK. Available online at: HMS Prince of Wales: Delayed carrier leaves Portsmouth – BBC News
CNN, (2024), ‘US Carries Out Retaliatory Stikes on Iranian-Linked Militia Targets in Iraq and Syria’ By N. Bertrand, H. Britzky, O. Liebermann, and K. Liptak, Cable News Network 2024, Warner Bros Inc. Available online at: US carries out retaliatory strikes on Iranian-linked militia targets in Iraq and Syria | CNN Politics
Euronews (2023), ‘New Risk to Inflation? Cost of the Red Sea Attacks on Global Trade,’ by D. Katanich with AP, Euronews. business 2023. Available online at: New risk to inflation? Cost of the Red Sea attacks on global trade | Euronews
Kuehne Hagel, (2024), ‘Suez Boxship passings Show Stability Despite Low Numbers’ Kuehne-Hagel Sea News 2024. Available online at: Suez boxship passings show stability despite low n… | myKN (kuehne-nagel.com)