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The latest U.S. inflation data shows prices remain hot, with core inflation still trending upward. Greg Bonnell speaks with Hafiz Noordin, Portfolio Manager, Global Fixed Income at TD Asset Management, about what’s driving prices higher and the impact on monetary policy.
Transcript
Greg Bonnell: Many central banks have been delivering jumbo-sized rate hikes in an attempt to tamp down red-hot inflation. But as we get into the final months of 2022, are there any signs of progress in that fight? Joining us now, Hafiz Noordin — he’s Portfolio Manager for Global Fixed Income at TD Asset Management. Great to have you back on the program.
Hafiz Noordin: Great. It’s a pleasure to be here.
Greg Bonnell: So let’s talk about that. There’s been plenty of pain in equities and bonds this year for investors, but all in the name of trying to fight inflation. How are we actually doing on that front?
Hafiz Noordin: Well, when we look at current levels of inflation, that’s one of the main performance metrics for central banks. Does feel like there’s still a lot of work to do. We had US CPI last week — the print for September — show that headline may be starting to stabilize, but core inflation ticked up again to 6.6%. That’s 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 now in terms of inflation momentum, less so the goods story.
So all that stuff about supply chains, all the bottlenecks, shipping costs — that story is starting to wane. And it’s really more the services story. And within that, it’s more about housing — so rent and owners’ equivalent rent, both at a run rate of about 7% to 8% now in the US. So really, on that basis, seems like there’s a lot of work to do. But I think it’s important to take a step back and think about, do we assess central banks on current levels inflation? Arguably, no. Monetary policy does work with about a two to three quarter lag. So when we look at forward-looking indicators, which we really monitor, there’s definitely evidence out there that the tightening that they’ve done so far is starting to have an effect in terms of cooling demand, bringing down inflation going into next year. But where it ends up is still a fair amount of uncertainty.
Greg Bonnell: Our central bank started the week by releasing their Business Outlook Survey and their Consumer Sentiment Survey as well. And I guess if you pushed out far enough on both surveys, there seems to be some faith that the central bank can get it under control. But right now, it seems to be a bit of concern out there, even among consumers, among businesses, that we could be headed for some tough times and that perhaps the inflation fight’s going to take a little while longer.
Hafiz Noordin: Right. Yeah. So you’re right to point out that long-term inflation expectations still look kind of anchored. So that’s the good news that came out of that survey. But one to two-year inflation expectation is still quite high. And I think the general takeaway from the Bank of Canada’s report there was that there’s a lot of uncertainty at a consumer level and a business level in terms of the inflation picture for the next year, and even the growth picture. And so for consumers and for workers, that means that they’re really looking towards wage growth to help them to buffer that shock. They’re demanding higher wages. And that’s the risk that we really have to look out for. It’s that wage price spiral.
If we see higher wages being given out to workers, then businesses will likely pass that on to higher prices for services and goods. And then, again, that’s a second order effect of higher inflation. And if that continues in the 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 come down meaningfully, we still should expect the Bank of Canada, and most central banks, to stay hawkish to prevent that scenario from ever happening because that’s the one 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 it Friday on the tail end of the IMF, or maybe the beginning of the IMF meetings, where he took questions from the media? Lots of tough talk. What else did we hear from those meetings? I mean, that was the gathering of these people who are charting this course.
Hafiz Noordin: Right, exactly. So a lot of things for them to talk about, but I think front and center is the growth outlook. So twice a year, at these meetings, the IMF releases a World Economic Outlook. Pretty downbeat picture for next year in terms of declining growth expectations and kind of around 2 and 1/2% to 3% global growth, but inflation still staying sticky at around 4% to 5% next year. I wouldn’t say that really fundamentally changed a lot in terms of the market’s expectations.
I think the private sector growth estimates and inflation estimates were already there. But I think what they brought out of those discussions, because of what has happened recently in the UK and some other countries, is this fiscal conundrum. And I think that’s going to be one of the new risks going forward that we really have to watch — this idea that a lot of households across the globe, dealing with higher borrowing costs, dealing with higher consumption costs. And they’re feeling the pain. And the pressure is on governments now to try to think of how do they buffer these shocks. We saw the UK do it the wrong way. But it doesn’t mean that that approach to 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 those types of measures.
Greg Bonnell: When it comes to trying to tame inflation, you mentioned shelter costs. And some people might say, oh, no, wait a minute, I keep seeing headlines about home prices coming down pretty dramatically in the face of higher borrowing costs. But of course, higher borrowing costs, then if you’re a homeowner, maybe you’ve got a floating rate mortgage, and you’re not getting a break there. And if you’re a renter, it doesn’t sound like you’re getting a break, either.
Hafiz Noordin: Yeah, that’s right. And the US is actually probably front and center here because we’ve seen mortgage rates go up very, very quickly there. The 30-year mortgage rate in the US is the one to watch for that market. It’s just over 7%, and that’s at an over 20-year high. So we’re definitely already seeing a lot of reduction in homebuyer sentiment. House prices have come down. But the reality is that we haven’t seen that show up in the CPI data. The rents and owner equivalent to rents are still going up. But I think what we should really watch are some of those forward-looking indicators. So Zillow is a good example of alternative data that does show that the rate of change of rents is starting to come down. So rents are still going up. But the pace of appreciation of rents is a bit lower now, compared to it was in the first half of the year. So perhaps a bit of a glimmer of hope there that it’s working its way into the inflation data and that the tightening measures that have been done so far will be sufficient. But it’s still fluid right now.
Greg Bonnell: Interesting, too, that you mentioned the central banks should be forward-looking because the moves they’re making right now are trying to effect change down the road. I think Beata Caranciis, TD’s Chief Economist, recently at events that I’ve been at — and she was on the show, and I was at an event with her — saying, curious, maybe, is a way to put it that the central bank seems to be focused on, OK, this inflation print comes out. We’re focused on it as investors. The central bank is focused on it. But all these things are backward-looking.
Hafiz Noordin: Yeah, that’s right. And that is the big challenge for monetary policymakers. It’s like driving a car and only looking in the rearview mirror. And that’s really the tough part of that job. But I think at the end of the day, one of the things that really came out from the IMF meetings and as they got feedback from investors was that uncertainties are increasing. And therefore, there is reason to perhaps slow down in terms of the pace of rate hikes. But that pivot that everybody’s waiting for —
Greg Bonnell: When you said “slow down,” the word “pivot” almost jumped off my mouth.
Hafiz Noordin: Exactly. Everybody’s waiting for that. But everything I talked about just now in terms of what we saw from the Business Outlook Survey in Canada — that risk of the wage price spiral — that is still front and center for central banks. And we know that they’ve been saying that they’d rather trade off lower growth or even a recession than let inflation really run away. And I think that’s what we have to expect going forward.
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