Photo: Wikimedia commons

By Michael O’Neill

“Inflation is transitory. Inflation is just temporary. Higher prices are only due to supply chain disruptions, and when the supply chain normalizes, prices will fall. Inflation is a little higher than it has been before, but it reflects higher oil prices in global markets, and higher prices for residential construction.” 

 Central bankers have made these and a litany of similar comments over the past several months to justify and defend their inaction to combat surging prices.

They may soon be changing their tune. US October inflation wasn’t just hot, it sizzled. CPI rose 0.9% m/m and, excluding energy food and energy, rose 0.6% m/m   The last time the annual rate was at 6.2% y/y, Ronald Reagan was President, and Justin’s dad was Canada’s Prime Minister.

Fed Chair Jerome Powell insists that inflation gains are temporary. He blames “dislocations caused by the pandemic, specifically the effects on supply and demand “from the economic shutdown for the increases and believes inflation will fall to the Fed’s 2.0% target, although the timing of the fall is uncertain.

Unfortunately, he may not be Fed Chair when the inflation target is met if some powerful Democrats get their way. Elizabeth Warren is one of them.

She is the Chair of the Senate Subcommittee on Economic Policy, which oversees economic growth, employment and price stability, and federal monetary policy. She has some clout.

Ms Warren told Powell she was not a member of his fan club at the Senate Banking Committee on September 28. She said, “The elephant in the room is whether you’re going to be renominated. Renominating you means gambling that, for the next five years, a Republican majority at the Federal Reserve, with a Republican chair who has regularly voted to deregulate Wall Street, won’t drive this economy over a financial cliff again.” She finished by saying “he was a dangerous man to head up the Fed.”

Other “progressives” (which is really another way of saying socialist) Democrats also want Powell replaced. Massachusetts Rep Ayanna Pressley and New York Rep Alexandria Ocasio-Carter are two.  They want a “reimagined Fed” to focus on climate change while advancing racial and economic justice.” It is a “woke” aspiration and if successful, would change the Fed’s mandate to “Economics Don’t Matter.”

The fact is that Jerome Powell is as good as any previous Fed Chair, but as usual, politics will trump (no pun intended) qualifications. Republican President Trump defied convention when he replaced a Democrat Fed Chair (Janet Yellen) with a fellow party member. (Powell).

President Biden may repay the favour.

This week he reportedly interviewed Lael Brainard for Jay’s job. She’s a Harvard grad with both a Masters and PhD in economics.  She has been a Fed Governor since January 2014, so she is well-versed in existing Fed policies and the outlook. She also ticks many of the boxes that progressive Democrats seek, including female and dovish. Even better, she hasn’t been accused of insider trading, like many of her Fed colleagues.

Nevertheless, the Federal Open Market Committee has twelve members when all the seats are filled, and the Chair is just one of them.

Inflation is not just a US problem. Canada CPI rose 4.4% y/y in September, and the drivers of domestic inflation are not any different than those south of the border, and the solutions will be the same as well.

A bigger issue for Canada, and the Canadian dollar is the outlook for oil. West Texas Intermediate closed on December 31 at $48.40/barrel while USDCAD finished at 1.2712.  WTI is trading at $81.80 on November 10 for a gain of 69%. Meanwhile, USDCAD has only declined 1.8% to 1.2480.  For a currency often tagged as a petro-currency, the USDCAD performance is pathetic.

Perhaps Canada’s progressive energy and climate change policies are discouraging foreign investment. If so, it is going to get worse. Canada’s Minister of the Environment Steven Guilbeault is a former Greenpeace radical. Guilbeault is rabidly anti-oilsands claiming operations are “dirty crude.”  Alberta claims in the Anti-Alberta Energy Campaigns report that  Mr Guilbeault’s Equiterre company “coordinated and facilitated campaigns seeking to frustrate further development of the Alberta oil sands, including by encouraging … individuals to de-invest from fossil fuels in Canada.”  Guilbeault opposed “the Energy East, Trailbreaker, Trans Mountain, Keystone XL and Line 9 pipelines.”

An Anti-energy Environment and Climate Change Minister may have severe repercussions for the domestic economy and Canadian dollar in light of the Michigan and Enbridge Line 5 pipeline dispute.

 Michigan revoked the 1953 easement that allows the pipeline to run 4.5 miles under the Straits of Mackinac, between Lake Michigan and Lake Huron. If allowed to stand, it imperils Ontario’s and Quebec’s crude supply.  The Line 5 pipeline provides 66% of Quebec’s and 50% of Ontario’s oil requirements.

The White House said it would await a full environmental review before any decision on the fate of Line 5. It would be catastrophic for Canada if Steven Guilbeault provided the assessment, but fortunately, he has another job.

If USDCAD cannot get any downside traction while oil prices are at a three-year high, where will the currency be when the existing demand/supply imbalance normalizes, expected to happen Q1 2022? Guessing somewhere close to 1.3500 makes sense.

Inflation may be sticking around, but USDCAD may be looking to move higher.

Chart: USDCAD and Oil daily

Source: Saxo Bank