With US inflation still stubbornly high, do interest rate hikes work?



The latest US inflation data shows that prices remain hot, with core inflation still trending higher. Greg Bonnell talks with Hafiz Noordin, Portfolio Manager, Global Fixed Income at TD Asset Management, about what’s driving prices up and the impact on monetary policy.


Greg Bonnell: Many central banks have made giant rate hikes in an effort to curb runaway inflation. But as we enter the final months of 2022, are there any signs of progress in this fight? Joining us now is Hafiz Noordin – he is a portfolio manager for global fixed income at TD Asset Management. It’s great to have you back on the program.

Hafez Noordin: Great. It’s a pleasure to be here.

Greg Bonnell: So let’s talk about it. Stocks and bonds have suffered a lot this year for investors, but all in the name of fighting inflation. How are we actually doing on this front?

Hafez Noordin: Well, when we look at current levels of inflation, it’s one of the main measures of central bank performance. I feel like there is still a lot of work to do. We had the US CPI last week – the September print – showing that the stock might start to stabilize, but core inflation rose again to 6.6%. This is a new high for the cycle. And when we drill down into the numbers, it’s the services part of the economy that’s driving the bus in terms of inflation dynamics, minus the goods story.

So all of the supply chains, all of the bottlenecks, shipping costs — that story is starting to fade. And it’s really more the story of services. And within that is more housing – so rent and equivalent landlord rent, both at a going rate of around 7% to 8% right now in the United States. So really, based on that, it looks like there’s a lot of work to be done. But I think it’s important to step back and think, do we rate central banks on current levels of inflation? Probably not. Monetary policy works with a lag of about two to three quarters. So when we look at the forward-looking indicators, which we really watch, there’s certainly some evidence that the tightening they’ve done so far is starting to have an effect in terms of cooling demand, pushing inflation down next year. But where it ends, there is still a fair amount of uncertainty.

Greg Bonnell: Our central bank started the week by releasing its Business Outlook Survey and Consumer Sentiment Survey. And I guess if you pushed far enough in both polls, there seems to be some confidence that the central bank can control it. But right now there seems to be a bit of concern, even among consumers, among businesses, that we could be heading into tough times and that maybe the fight against inflation is going to take a little longer time.

Hafez Noordin: Right. Yeah. You are therefore right to point out that long-term inflation expectations still seem to be anchored. This is the good news that emerges from this survey. But one- or two-year inflation expectations are still quite high. And I think the overall conclusion of the Bank of Canada report was that there’s a lot of uncertainty at the consumer and business level in terms of the inflation picture for next year, and even growth. And so for consumers and for workers, that means they’re really looking to wage growth to help them cushion this blow. They demand higher wages. And that’s the risk we really have to watch out for. It’s this price-wage spiral.

If we see higher wages paid to workers, companies will likely pass this on in higher prices for services and goods. And then, again, it’s a second-order effect of higher inflation. And if it continues to spiral, that’s really where the Bank of Canada can lose control. So I think the key message for investors is that even if growth starts to slow significantly, we should still expect the Bank of Canada and most central banks to remain hawkish to prevent this scenario from unfolding. happen, because that’s where we can really lose control of the economy.

Greg Bonnell: I think the last time we heard from our central banker, Tiff Macklem, was on Friday at the end of the IMF, or maybe at the start of the IMF meetings, where he answered questions from the media? Lots of difficult discussions. What else have we heard from these meetings? I mean, it was the gathering of these people who are forging this path.

Hafez Noordin: Exactly. So there are a lot of things they need to talk about, but I think growth prospects are at the forefront. Thus, twice a year, during these meetings, the IMF publishes the Prospects of the world economy. Pretty gloomy picture for next year in terms of lower growth expectations and global growth of around 2 and 1/2% to 3%, but inflation remains stable at around 4% to 5% the next year. I wouldn’t say it fundamentally changed much in terms of market expectations.

I think the private sector growth estimates and the inflation estimates were already there. But I think what they’ve brought out of those discussions, because of what’s happened recently in the UK and other countries, is this tax conundrum. And I think that’s going to be one of the new risks going forward that we really need to watch out for — this idea that a lot of households around the world, facing higher borrowing costs, facing consumption costs higher. And they feel the pain. And the pressure is now on governments to try to think about how they cushion these shocks. We have seen the UK do it the wrong way. But that doesn’t mean that this approach of having some sort of fiscal stimulus is gone. That pressure is going to be there. And I think that’s the risk to watch in terms of who’s next to try these kinds of measures.

Greg Bonnell: When it comes to trying to control inflation, you mentioned housing costs. And some people might say, oh, no, wait a minute, I keep seeing the headlines about house prices dropping quite dramatically in the face of higher borrowing costs. But of course, higher borrowing costs, so if you’re a homeowner, maybe you have an adjustable rate mortgage, and you don’t get a break there. And if you’re a tenant, it doesn’t look like you’re taking a break either.

Hafez Noordin: Yes, it’s true. And the United States is actually probably leading here because we’ve seen mortgage rates go up very, very quickly there. The US 30-year mortgage rate is the one to watch for this market. It’s just over 7%, and it’s at a 20+ year high. So we are already seeing a sharp drop in homebuyer sentiment. House prices have gone down. But the reality is that we haven’t seen that show up in the CPI data. Rents and owner’s equivalent of rents are still on the rise. But I think what we really should be watching are some of these forward-looking indicators. Zillow is therefore a good example of alternative data that shows that the rate of change in rents is starting to fall. Rents therefore continue to rise. But the pace of rent appreciation is a bit slower now than it was in the first half. So maybe a small glimmer of hope that it finds its way into the inflation data and that the tightening measures that have been taken so far will be sufficient. But it’s still fluid right now.

Greg Bonnell: It’s also interesting that you mentioned that central banks should be forward looking, as the actions they are taking right now are trying to bring about change in the future. I think Beata Caranciis, TD’s chief economist, has been at events recently that I’ve attended — and she was on the show, and I was at an event with her — say, curious, maybe -be, is a way of saying that the central bank seems to be focused on, OK, this impression of inflation comes out. We focus on that as investors. The central bank is focusing on it. But all these things are backslidden.

Hafez Noordin: Yes, it’s true. And that is the big challenge for monetary policy makers. It’s like driving a car and only looking in the rear view mirror. And that’s really the hardest part of this job. But I think at the end of the day, one of the things that has really come out of the IMF meetings and the investor reactions is that the uncertainties are growing. And so, there may be room to slow down in terms of the pace of rate hikes. But that pivot everyone’s been waiting for —

Greg Bonnell: When you said “slow down”, the word “pivot” almost jumped out of my mouth.

Hafez Noordin: Exactly. Everyone is waiting for this. But everything I talked about earlier in terms of what we saw in the Canadian Business Outlook Survey — this risk of spiraling wage prices — which is always at the center of central bank concerns. And we know they’ve said they’d rather forgo weaker growth or even a recession than let inflation soar. And I think that’s what we should expect in the future.

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