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Inflation and FX Depreciation Spirals - Global Exchanges

FICC Podcasts 18 mai 2021
FICC Podcasts 18 mai 2021


Disponible en anglais seulement.

In this episode, we discuss the continued rally in global commodity prices, the associated sharp uptick in inflation numbers in some countries and the renewed downdrift in the US dollar.

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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

Podcast Disclaimer


Greg Anderson: Hi. Welcome to episode nine of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host, Stephen Gallo and I will be talking about the continued rally in global commodity prices, the associated sharp uptake in inflation numbers in some countries, and the renewed downdrift in the US dollar. The title for this episode is Inflation and FX Depreciation Spirals.

Stephen Gallo: Hi. I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson: Hi. I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's cohost.

Stephen Gallo: In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson: We strive to make this show as interactive as possible. So don't hesitate to reach out by going to exchanges. Thanks for joining us.

Speaker 3: The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Stephen Gallo: Well Greg it's May 18th, 2021. It's been a little while since we did our last podcast, but I have to say there have been some important moves in commodity indices in between our podcasts. We've hit new highs for the cycle in a number of key commodities, commodity indices that is. And in that context, especially with central bank easing still in play and fiscal deficits widening, you kind of have to think to yourself, are we seeing the classic case of too much money chasing too few goods? And is debasement really starting to have an impact, in some sense on currencies on the FX market, but on commodity prices? And I guess to that picture, we have to talk about the fact that the dollar is drifting lower again, it looks increasingly like it's going to have another leg lower. Is there a link between the inflation picture, the rise in commodity prices, the fact that there could be too much money chasing too few goods in the system? Are we seeing this classic case play out right in front of our eyes?

Greg Anderson: Great tease Stephen. Nice job dropping the old-school economist tagline about inflation being the product of too much money chasing too few goods. That's the explanation from the old textbooks and those textbooks are the way that you and I, along with the vast majority of market participants, know about the inflation problems from days of yore. Back in the 1970s, there was a fairly severe inflation problem that was described with the line you just used. And it was accompanied by a US dollar devaluation, then the end of Bretton Woods, and then more US dollar depreciation as the decade went on.

There are very few policymakers, politicians, or investors left standing who were mature participants in that economy. So I don't think there is much muscle memory in the market regarding inflation spikes and inflation depreciation twin spirals. I happened to live in Peru in the late 1980s, and was old enough to sort of feel the power of an inflation/depreciation spiral. So I kind of know that it can bring a lot of turmoil, but hey, that was an emerging market and a long time ago.

This couldn't happen now in a big country like the US, right? Well, maybe I'm still carrying some psychological scars, but I'm still a little more leery of one of these spirals than your average American politician. I worry that we're about to find out that accelerating inflation and possibly linked dollar depreciation aren't as easy for the Fed to deal with as chair Powell has said that it is.

Stephen Gallo: Greg I think what you offered there is just fascinating, and highlighting the 1970s was I think, a great place to go decade wise. And I'm reminded of the 1970s in Britain, at least the story anyway, and the stubbornly high inflation, which resulted in a balance of payments crisis and a sterling devaluation in 1976. So the other thing I'm looking closely at, in this inflationary picture we're talking about, is the US's widening trade deficit. And I guess we have to add that to the conversation about the dollar, right?

Greg Anderson: Wow. You always know how to rile me up into a rant! But before I start going off on the US trade deficit tangent, let's circle back to inflation and talk about the numbers a bit. That a 4.2% year over year CPI number that we got from the US in April, is that happening in the economies you cover?

Stephen Gallo: Actually, Greg, that's a good point. We should just turn to the evidence we've got so far in terms of where CPI inflation readings have been hot and where they've been not so hot and just see where we go from there. So when we look at the raw data on CPI inflation from across the globe, the first things that stands out to me are the relatively low inflation readings out of parts of Asia, India's of course as always one exception, but parts of Asia or most of Asia and parts of Europe. And I'm wondering if maybe we can pin these readings down to demographics, the banking systems, the relative size of the consumer market in these places, the differing psychologies of businesses and households.

So that may be a factor globally, and also, for example, within Europe itself differentiating between Western Europe and countries in Central and Eastern Europe. But then once I finished that kind of brief analysis, I turn to the situation in the Americas. And in the Americas it seems to me we're getting some really bulky readings in CPI inflation North of 4% if we go off the CPI in the US the most recent one, 7% nearly in Brazil, just above 6% in Mexico. Greg, I have to ask you, do you have a story for this? Is there something that you think is relevant to those currencies that's related to this inflation data from the Americas?

Greg Anderson: Before going on to what might be making the Americas different, I just want to point out that the most recent total inflation numbers elsewhere are as follows. We've got 0.9% year over year in China, minus 0.2% year over year in Japan. 1.6% year over year in the Eurozone and just 0.7% year over year in the UK. So assuming that when we get Canada's April CPI number tomorrow it’s above 3% as expected, these 3% plus readings in the Americas really are unique.

Stephen Gallo: Great Greg. So just to repeat my question, do you have a story for that?

Greg Anderson: Maybe. I'll give it my best shot. But let me start by saying that global commodity price rises are global. So if oil goes up 10% in the Americas, it goes up pretty close to the same amount in Asia and in Europe. The same goes for base metals, basic food prices, et cetera. And I even think the same is true for things like computer chips, which are in short supply globally right now. So what's different in the Americas isn't in the inputs part of the inflation formula, it's in the price making firms do with finished goods prices. They can either absorb higher input costs into narrower margins. And it seems like that is probably what is happening in Asia, or they can raise prices and try to pass along higher input costs to the final consumer. That seems to be what is happening in the Americas. I've got a great anecdote on that.

In that a shocking US CPI number, we had used cars up 10% month over month and 21% year over year. That has got to be used car dealerships, that normally operate on very thin margins by the way, recognizing that they've got pricing power and passing on the higher prices they're paying to acquire vehicles to the end consumer. That just doesn't seem to be happening in the same way in Asia, maybe with higher chip prices leading to higher cell phone prices, et cetera. Why? I'm not sure. Maybe it's just what you talked about Stephen, too much money chasing too few goods in the US because a lot of free money has been handed out by the US's fiscal and monetary policies.

Stephen Gallo: So too much money chasing too few goods is at least one possibility Greg, if I read you right from your comments. I guess this leads me to the next area of exploration, which is the central bank reaction function. In other words, are there potentially issues here that would force a central bank to have to respond and therefore cause a pickup in FX volatility? In my neck of the woods, particularly when I think of the Eurozone, watching how the inflation dynamic plays out and the ECB's ultimate response to it will be fascinating I think because there is a really important trade-off that the ECB has to make between causing volatility in the bond market and playing a game of chicken with inflation, if it characterizes any uptick in price pressures as transitory.

Greg Anderson: So in my neck of the woods, I have to start with the Fed, which I think other central banks like the BoC have to be careful not to get too far ahead of. So with the Fed, I think we've got a much different reaction function than we've ever had in the past. And I think markets are still struggling to wrap their heads around it. Gone are the days when the Fed chair perceived his job to be taking away the punch bowl just when the party starts getting good. We now seem to be in the days of the Fed doing its best to call everyone in the neighborhood, to invite them to the party. And then if they don't want to come, promising them that it won't start talking about talking about winding down the party until late into the night. This could lead to a lot more US dollar depreciation than expected, and then a really sharp US dollar surge at the end, when the Fed finally has no other choice other than to end the party, because the cops are at the door.

Stephen Gallo: Greg that's a great use of the party analogy and I think it also serves to highlight a really profound point, which is that the engaging in quasi or partial normalization of policy while the Fed is keeping the party going is a lot easier for other world central banks to execute when financial conditions are relatively loose, like they are now. And the rapid tightening of Fed policy is not on the immediate horizon. And we've seen some central banks do just that, including the People's Bank of China, which has been engaging in a bit of policy normalization itself. So bringing it back to FX, bringing the conversation back to FX, one thing that is supporting European currencies right now is of course the dollar weakness, which we spoke about, but also the fact that investors are becoming more mindful that European bond yields are creeping up again.

Greg Anderson: European bond yields creeping up, global commodity prices continuing to creep up, the US dollar drifting down. I don't have any further magical insights other than the age old technician's adage, that the trend is your friend, at least until the end, when there's a bend. Will the inflation spike gets so out of control that the Fed calls an end? Maybe, but they're not talking about talking about it right now. So the best thing I've got to say is to remain short US dollars and long commodity currencies like CAD, AUD and NZD.

Stephen Gallo: That's exactly right, Greg. I couldn't agree more. Long things people need and have demand for until the party's over. I think this is a great place to wrap up. Many thanks as always to our listeners, best of luck, of course, in markets, and we'll be back with our next Global Exchanges podcast on May 25th.

Greg Anderson: Thanks for listening to Global Exchanges, listen to past episodes and find transcripts at exchanges.

Stephen Gallo:  We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson: This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group, and BMO's marketing team. This show is produced and edited by Puddle Creative.

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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