By Michael O’Neill
The US Consumer Price Index (CPI) surged to 7.9% y/y in February while Canada’s CPI jumped to 5.7% y/y. The increases are at the highest levels since 1982. Despite assertations to the contrary, the Fed and the Bank of Canada actions are sharply lagging inflation trajectories in the US and Canada.
If managing inflation was a game of pool, the bankers appear to be positioned behind the 8-ball, usually a losing proposition.
Should you be worried? Maybe, maybe not.
The central bankers want their constituents to believe they have things under control. At first, Fed Chair Jerome Powell blamed supply chain disruptions for the surge in prices and then two weeks ago he admitted to Congress that “Supply disruptions have been larger and longer lasting than anticipated, exacerbated by waves of the virus, and price increases are now spreading to a broader range of goods and services.”
Bank of Canada Governor Tiff Macklem agrees with Mr Powell’s inflation assessment, and both said the Russian/Ukraine war exacerbated price increases. Nevertheless, there were some specific “Made in Canada” components to the February inflation surge and the expected April increase as well.
Chart: Change in Canada CPI
Source: Bank of Canada
The Federal government’s Canadian Dairy Commission regulated an 8.4% increase in farm gate milk prices for retail and restaurants, which drove milk prices up 7.0% y/y. And that is nothing to “moo” about.
Justin Trudeau’s Liberal government gets into the act beginning April 1 (yes, we are all April’s Fools) with his planned 25% carbon tax increase. That will add around 12 cents /liter to gas prices before the Feds and provincial governments tack on HST taxes.
China President Xi Jinping is chortling into his noodles as the man he calls “Little Potato” actively undermines Canada’s energy industry, and Canadians pay the price.
China’s total CO2 emissions are nearly 17 times Canada’s and are likely to worsen as China plans to build another 242 coal-fired plants. Canada can shutter its entire fossil fuel industry, and global CO2 emissions will continue to rise.
The central bank’s reaction to inflation has been tepid. The Bank of Canada raised interest rates by 0.25% to 0.50% on March 2, and the Fed hiked rates by 0.25% on March 16. They may be turning up the heat soon as both banks admitted that ongoing rate hikes would be necessary.
The issue is one of credibility. The Fed’s reaction to inflation rivals that of the various government health agencies to the pandemic. Canadian authorities responded to the COVID-19 pandemic by claiming masks were unnecessary, and people just needed to wash their hands frequently. That advice eventually changed to “stay-at-home” orders, mandatory mask-wearing, and travel bans. The American’s experience was just as bad and exacerbated by then-President Trump advocating dubious COVID-19 treatments.
Fed Chair Jerome Powell and his colleagues were dismissive of rising inflation, stubbornly insisting it was transitory, until December when they set the stage for eventual rate increases.
The December Summary of Economic (SEP) projections predicted at least three rate hikes in 2022, a sharp jump from September when only one increase was projected.
The March SEP forecasts another six more rate hikes in 2022, which, when compared to September, screams “Policymaker Panic.”
But that’s ok. The Fed and BoC need to raise interest rates as the economy no longer needs stimulus from ultra-low levels.
The BoC suggests the nominal neutral rate is between 1.75-2.5%, while the Fed believes the neutral rate is around 2.5%. Rates are going higher, and the only question is whether they rise in 0.25% or 0.50% increments.
Unfortunately, the direction of the Canadian dollar is far less clear. The Russian invasion of Ukraine interrupted the USDCAD correlation with oil prices. WTI soared on supply disruption concerns while USDCAD rallied on safe-haven demand for US dollars.
USDCAD price action correlated nicely with S&P 500 index price movements. That relationship is likely to continue because the index is a major barometer of risk sentiment, and the US dollar is the currency of choice.
Traditionally, rising interest rates and high inflation are major negatives for stock markets. Arguably, the S&P 500 rally from the pandemic low is overdue for a steep correction. The index dropped 13.4% on the back of the Russian hostilities, and so far, the bounce is of the dead cat variety. Prices could fall another 20% and still be in an uptrend from the 2009 low. Such a move would imply a “risk-averse” environment and support USDCAD.
The central banks may be behind the 8-ball, but the game is not over.