War is a racket. It always has been. It is possibly the oldest, easily the most profitable, surely the most vicious. It is the only one international in scope. It is the only one in which the profits are reckoned in dollars and the losses in lives. A racket is best described, I believe, as something that is not what it seems to the majority of the people. Only a small ‘inside’ group knows what it is about. It is conducted for the benefit of the very few, at the expense of the very many. Out of war a few people make huge fortunes–Smedley Butler
In this Issue
Will Street Inflation Spike? Global Wheat Prices Go Ballistic! Oil Prices Rockets to 8-Year Highs! Gold in Peso Hits All-Time Highs!
I. Oil Price Rockets to 8-Year Highs!
II. BSP’s Perilous Gambit: The "Low" CPI as Justification for Easy Monetary Policies
III. Spiking Oil Prices Have Bled the Transport Industry!
IV. Declining Food CPI: Tsunami of Supplies or Sluggish Demand? Or Sugarcoating Statistics?
V. Why Street Inflation May Be About to Zoom: Resumption of Credit Expansion
VI. Kaboom! USD Breaks US 51.5! Why the Peso Depreciation Should Escalate Street Inflation! Gold in Peso Hits ALL-TIME HIGH!
VII. Spiking Global Wheat Prices and Other Commodities Should Send Street Inflation Higher!
VIII. The Transition to a New Order: From Globalization to De-Globalization, Stagflation and Financial Crisis
Will Street Inflation Spike? Global Wheat Prices Go Ballistic! Oil Prices Rockets to 8-Year Highs! Gold in Peso Hits All-Time Highs!
I. Oil Price Rockets to 8-Year Highs!
Figure 1
The US and European oil benchmarks WTI and BRENT stormed to their highest levels since 2014! The indicated prices are as of March 2. (Figure 1, topmost pane)
WTI and Brent closed at USD 115.7 and 117.4 on Friday, March 4.
II. BSP’s Perilous Gambit: The "Low" CPI as Justification for Easy Monetary Policies
Authorities announced this week that the benchmark of statistical inflation, the CPI, held steady at 3% last February.
From our perspective, since the statistical inflation or the CPI anchors the BSP policies, compressing it has justified zero-bound policy rates to rescue the banking system, balloon the GDP, boost the peso, and inflate away public liabilities.
As such, a significant understatement of the CPI could be a strong possibility.
For this reason, the Philippine Statistical Authority (PSA) readjust its baseline every 6-years.
Such alteration effectively reduces the CPI by effacing the price changes from the previous baseline.
See How to Chop the CPI? Change the Baseline Rates! T-Bill Yields Plunge to All-Time Lows as Credit Spreads Tighten! February 6, 2022
Secondly, other inflation measures are contradictory to the CPI. (Figure 1, middle window)
While the CPI remains the most politically sensitive statistic, the PSA has other statistical measures of inflation to countercheck each other.
The PPI is a measure of factory inflation. The General Wholesale Price Index GWPI represents the price changes of wholesale intermediaries.
The General Retail Price Index GRPI provides the price change estimates of the retail trade sector as sold to the end-users or consumers.
Here is the thing. The CPI and the GRPI should resonate, although the variances in the basket composite contribute to minor differences.
As an aside, the publication of the CPI is about two-three months ahead of the GRPI.
In the meantime, if factories sell their goods to the distributors, then the PPI should show confluence with the wholesale GWPI.
And since wholesalers/distributors sell to the retail trade sector, the price differentials should provide a clue of the profit margins earned by the retailers.
While deflation has clouded the PPI for a remarkable string of 29 months from April 2019, it reversed course in September 2021, and strongly bounced this January.
Deflation here means that supply has been greater than demand. The supply gluts have emerged from overproduction and/or excessive imports, or that sluggish demand has led to lower prices.
And yet, wholesale prices remain in an uptrend from 2019, accelerating in 2021 through November. The irony is that strong demand in wholesale prices has been insufficient to boost domestic production until 2021.
From here, wholesalers must have enjoyed a bonanza while producers suffered! Imports should have filled this gap, but no. Imports rebounded only starting in the 2Q of 2021. (Figure 1, lowest pane)
Better yet, booming wholesale prices in the face of subdued retail price growth translates to a margin squeeze for the latter!
And because this relationship is unsustainable, as mounting losses mean a reduction of demand for wholesale products, wholesale prices should eventually reflect on retail conditions.
The various inflation statistics of the government signifies a mishmash of contradiction.
Here is more.
IHS Markit saw a substantial improvement in the factory PMI last February (March 1, 2022): To support output growth, manufacturers raised their buying activity in February. The rate of growth was sharp, and the steepest for over three years. With demand improving, manufacturers increased stockpiling efforts to cater for stronger demand conditions. Pre-production inventories have now increased in each of the last six months. Despite solid uplifts in sales, firms held back on hiring activity. Employment levels have now fallen continuously for two years, with the latest reduction the quickest for five months. Anecdotal evidence suggested that resignations drove the decline, rather than firms engaging in cost-saving efforts. Despite lower headcounts, firms kept on top of workloads as signalled by a solid drop in backlogs of work. Spare capacity allowed firms to add to post-production inventories during February, with stocks rising sharply, and at the quickest rate for five years. Anecdotal evidence suggested panellists anticipated greater demand in the coming months and added to stock levels in preparation. Supply chain issues persisted in February, although the extent to which lead times lengthened was the weakest for a year. Reports of port congestions and transportation bottlenecks persisted, but firms also mentioned improvements in material availability. As for prices, higher energy, raw material, fuel and transportation costs drove up expenses in the second month of the year. The rate of input price inflation was robust, and much stronger than the long-run series average. Subsequently, firms raised their selling charges, and at the joint-quickest rate in the current 22-month sequence of inflation.
Except for the sharp and steepest growth, the IHS Markit has repeatedly told of the same stagflationary characteristics: unemployment, rising input, and output costs.
If growth has been impressive, why are producers holding back on investments, thereby hiring? Lagging effect, perhaps? Or is the reported growth about protecting profits from anticipated inflation by increasing current output?
Third, the financial markets differ materially from the opinions of the consensus.
Figure 2
The contortion of public data exposes why treasury traders continue to bet massively against the policies of the BSP based on the CPI, enlarging what the mainstream calls the risks of "policy error."
Philippine 10-year Treasury bonds continue to scale higher, despite low inflation and the historically low policy rates of the BSP! (Figure 2, upmost pane)
After the CPI announcement last Friday, treasury traders sold shorter maturity bonds while bidding higher on the long-term and T-bills, which barely is the response the BSP expects. (Figure 2, second to the highest window)
The USD-Peso dollar has also contradicted them.
In this case, the media barely covers the opinions or analysis of traders of the treasury and FX markets.
Yet, these are the same people who set prices at the margins for these critically important markets. These market participants are hardly outliers; they belong to mainstream institutions.
The takeaway is what you see/hear/read in media is not what you get.
No one ever talks about the principal-agent dilemma in the conveyance of market assessment to the public. Most people imbibe "hook, line, and sinker" what the establishment copywriters tells them.
Nonetheless, by insisting on the present zero-lower bound policies, the BSP seems to be gambling with the economy.
III. Spiking Oil Prices Have Bled the Transport Industry!
Gambling?
Yes, even from the statistics of the PSA, imbalances are already surfacing.
Though the housing and utility CPI (housing, electricity, gas, & water) managed to adjust along with spiking in oil prices, the transport CPI has lagged substantially. (Figure 2, second to the lowest and lowest windows)
It means that the price caps in the face of surging input costs must have been squeezing margins and earnings of the industry.
The former has a basket weight of 21.38%, the second largest after Food and Beverage. Meanwhile, the transport CPI carries a 9.03% weight.
Since oil prices have raced ahead of the Transport CPI since August 2021, anxiety in the sector has mounted.
No wonder a public transport group demanded authorities to allow a Php 6 or a 66.67% hike in passenger fare last week.
Such maladjustments are barely indicators of growth.
Instead, it represents the depreciation of the standards of living of the sector. Again, the CPI reveals none of these ramifications on the individual.
Such also shows that price changes are hardly reflected accurately in the CPI because of regulatory measures such as Suggested Retail Pricing SRPs and direct price controls.
We can also presuppose that excluded from the calculation of the CPI are transactions in the informal sector.
IV. Declining Food CPI: Tsunami of Supplies or Sluggish Demand? Or Sugarcoating Statistics?
Authorities have focused on the Food CPI because its 37.75% share weight is the largest in the basket.
By controlling food prices, the CPI submissively follows.
The Food and Non-Alcoholic beverage (FNA) CPI used to have a tight correlation with the US West Texas Crude Oil (WTIC). Such correlation broke in the 2H of 2021.
Supply issues appear to have predicated the immediate decline in the FNA.
That is, supply has benefited from an avalanche of imports or harvests/production, or demand for FNA has been less than supply.
The irony is, aside from oil, higher costs of fertilizer and feeds would have forced producers and traders to have shifted price increases to the public or suffer a margin squeeze.
A restrained pass-through would lead to reduced supply, which would place further pressure on consumer prices.
Or, are authorities telling us that despite ardently selling the GDP to the public, a constraint in demand is the reason for slowing FNA?
So which is which? The torrent of supply or sluggish demand? Or "do whatever it takes" to lower it to justify the BSP's policies?
V. Why Street Inflation May Be About to Zoom: Resumption of Credit Expansion
Regardless of what authorities does, the street inflation may be about to go berserk.
First, credit expansion may be inflating demand artificially.
The recent sharp rebound of the money supply growth, mainly from bank lending, should have boosted consumer demand even for food.
But let us grant that this may be about the lagging effect of spending. The reinvigoration of credit implies that sectors benefiting from it will power demand for food and other items.
Figure 3
M3 jumped 9.8% in January as universal and bank lending expanded by 8.5%, the fastest rate since June 2020, led by the sectors most sensitive to interest rates, real estate (16.8%), and financials (17.12%). (Figure 3, top and middle windows)
As an aside, while the consensus paints such credit transactions as growth-related, we propound a different angle: such industries are front-running the prospects of higher rates!
So aside from bank lending, indirect BSP operations through the banking industry generate liquidity in the said sectors (banks, government, and real estate). The banking industry's net claims on the central government grew by 19.6% in January 2022.
Meanwhile, the BSP's net claims on the central government retreated by 9.73% over the same period. (Figure 3, lowest pane)
So, aside from BSP operations, public spending will remain vigorous, especially with the coming national elections.
The bottom line: increased credit activities of banks, the BSP, and vigorous public spending will likely fuel the demand side.
VI. Kaboom! USD Breaks US 51.5! Why the Peso Depreciation Should Escalate Street Inflation! Gold in Peso Hits ALL-TIME HIGH!
Second, USD-Peso may be about to weaken substantially.
Figure 4
The USD-peso jumped by .78% to puncture into the critical 51.5 level last week. If momentum persists, we should see the USD-peso breeze past the Php 52.0 level this week or the next. (Figure 4, topmost pane)
Because of the attribution bias, the consensus mechanically ascribes the infirmities of the peso to exogenous forces, such as the implied Fed rate hike, Russia-Ukraine conflict, et.al.
The general idea is that external forces are responsible for the "negative" prices while internal strength drives the "positive" ones.
The reality is the FX exchange rates reflect domestic concerns. While not to be discounted, external factors influence domestic conditions through multiple channels. Hence, FX exchange rates manifest the influence of external forces on domestic conditions.
While regional currencies generally weakened against the USD this week, the USD peso was the third-best performer after India’s rupee, USD-INR (1.16%), and South Korea’s won, USD-KRW (1.04%). Malaysia’s ringgit USD-MYR defied the tide to drop by .6%. (Figure 4, second to the highest pane)
Needless to say, the FX markets factored in the disparity of the impact of external developments on national conditions.
Nevertheless, all things equal, more pesos are required to acquire foreign goods, which means higher costs of imports. This assumes the prices of foreign goods are static.
But since the world is suffering from a surge in commodity prices, the weak peso amplifies the price surge locally.
For instance, spot gold priced in the Philippine peso has barreled through the 99,000 resistance to forge an ALL-TIME HIGH! (Figure 4, third to the lowest pane)
And while the mainstream sees traditional metrics as the cause of the FX fluctuations, we see the USD-Peso substantially determined by exposure of the BSP and financial system to the "USD shorts" or borrowed reserves. (Figure 4, lowest pane)
More to that point. From 2018, the BSP used the Other Reserve assets or derivatives to boost the peso through reserve expansion. Data from the International Reserves and Foreign Currency Liquidity of the IMF.
However, the law of diminishing returns tells us that these interventions are failing to deliver the objective of controlling the fall of the peso.
A tightening of global liquidity should substantially increase the cost of such interventions leading to decreased support of the peso.
Also, US dollar "shorts" or borrowed reserves translates to increased demand for USD to pay for such interventions, existing liabilities, and trade financing.
Please see External Debt Growth Accelerates in Q3! Why This Uptrend Will Continue, December 19, 2021
The rising costs of servicing will likely prompt the BSP to scale down its borrowed reserves, which could likely lead to lower GIR over time.
From a chart perspective, the USD may test the 2018 resistance of 54.3 level soon. If it succeeds, it will bring to the forefront the target of 56.3-5 resistance level of 2004 to 2006.
VII. Spiking Global Wheat Prices and Other Commodities Should Send Street Inflation Higher!
Third, spiking commodity prices led by food will likely diffuse domestically.
The massive dislocations Russia-Ukraine war will escalate or compound the effects of the accrued imbalances from a combination of past and present factors, such as reduced investments in commodities due to the excessive focus on technology and environment, protectionist policies, and the disruption from the political response to the pandemic.
Figure 5
Wheat may be a principal transmission point for the potential outbreak of food price spikes!
The Philippines imports all of its wheat requirements.
From the World-Grain.com, November 18, 2019: “With no commercial production of wheat or ‘small grains’ in the Philippines, the country is a major importer of milling quality wheat and the United States is its largest supplier,” the USDA attaché said in an annual report on the grains sector. “Rising incomes and a rapidly growing population have resulted in changing diets toward more wheat and protein… … …Bakery products account for about half of milling wheat consumption. “This includes pan de sal and its derivatives (local salt bread consumed as a breakfast muffin), loaf bread, buns and rolls, cakes and pastries, and Chinese steamed buns,” the attaché said. “The other half of milling wheat demand is for producing noodles, cookies and crackers, and pasta.”
Aside from the US, Ukraine represents a significant source of Philippine wheat imports! (Figure 5, topmost pane)
According to their pecking order in metric tons, the top 10 wheat-producing countries are China, India, Russia, United States, France, Australia, Canada, Pakistan, Ukraine, and Germany.
Including coarse grains, Russia and Ukraine production account for a quarter of global trade! (Figure 5, middle window)
The price spike of wheat last week signified a critical disorder in its global supply networks. (Figure 5, lowest pane)
Unless other nations step up on the production to replace the vacuum and rearrange the supply flow, domestic prices of bread, noodles, and pasta may be about to go on a rampage!
And raging prices of wheat-based products may prompt consumers to shift to rice, which would send rice prices rocketing too!
One thing leads to another!
But there’s more.
Bloomberg/Yahoo, March 5, 2022: Governments around the world are taking steps to safeguard domestic food supplies after Russia’s invasion of Ukraine roiled trade and sent prices of key staples soaring. Hungary is banning grain exports, its agriculture minister told television channel RTL on Friday. Argentina and Turkey also made moves this week to increase their control over local products. And Moldova, albeit a small shipper, temporarily halted exports of wheat, corn and sugar from this month. Protectionist measures -- which already picked up in recent years as the Covid-19 pandemic sparked worries about local supplies and high prices -- could spell more bad news for global food trade. The war in Ukraine has brought crop shipments from much of the crucial Black Sea region to a halt, heightening fears of shortages of grain and sunflower oil.
Still more!
Bloomberg, March 5, 2022: Russia’s efforts to halt fertilizer exports by domestic producers threatens to shock the global market and push prices of crop nutrients to new records, exacerbating food inflation around the world. The Ministry of Industry and Trade urged Russian fertilizer producers cut volumes to farmers due to delivery issues with foreign logistics companies, according to a Friday statement. The country, which has been facing increasing international sanctions since invading Ukraine last week, is a major low-cost exporter of every type of crop nutrient. “Losing Russia and their large export volumes would be a severe supply-side shock to the market,” Alexis Maxwell, an analyst for Bloomberg’s Green Markets, said in an email. Russia’s move adds uncertainty to the global market when farmers in Brazil -- the world’s largest fertilizer importer -- are already having trouble getting nutrients for crops. The South American nation leads global exports of soybeans, coffee and sugar, so prospects of reduced availability of fertilizer and higher costs could worsen food inflation. The threat of a rail strike in Canada, the world’s top potash supplier, also raises risks of industry disruption.
The world appears to be embracing not just to eliminate trade with Russia but also reduce transactions with the people of other nations! Protectionism is on the rise!
Figure 6
As a reminder, global food prices have been spiraling higher even before the Russian-Ukraine crisis. (Figure 6, upmost window)
When food prices reached this level in 2010, it coincided or may have even fomented the Arab Spring, or anti-government protests, uprisings, and rebellion in the Middle East.
And price pressures are spreading across the commodity frontier!
Aside from oil and other energy products, surging prices have affected industrial metals and other food products. The Bloomberg Commodity Index posted its highest ever daily change since 2009! (Figure 6, middle pane)
Again, first-order effects lead to the second, the third, and more.
For instance, in the United Kingdom, rocketing energy prices have prompted some companies to suspend production, escalating supply issues across a broader spectrum of the economy.
Disruptions in one chain lead to displacements across overlapping networks resulting in complex feedback loops.
The domestic treasury markets may be pricing in such factors simultaneously with the financial of the banking system.
VIII. The Transition to a New Order: From Globalization to De-Globalization, Stagflation and Financial Crisis
It is alluring to infer that booming commodities across the board in the backdrop of faltering risk assets represent what the great Austrian economist Ludwig von Mises called the "crack-up boom" or the path towards hyperinflation. But present evidence suggests that this may not be the case yet. Let us not forget that the crack-up boom is a process.
Nevertheless, this gradation showcases the metamorphosis of the global economy into a new order.
That is, as the world transits away from globalization towards deglobalization, increasing reliance on regionalization, or at worst, localization or autarky, will characterize international relationships.
The evolution to the new geopolitical and economic order also portends to diminished social cooperation, increased economic discoordination, heightened societal fragmentation, and thereby amplifies social friction.
Since globalization served as the groundwork of the "everything asset bubble," the backsliding of the current system magnifies the risks of a global financial crisis.
Worst, it magnifies the temptation for leaders to indulge in a kinetic world war.
In the local setting, the lethal combination of domestic credit expansion signifying demand and dislocations in global and domestic supply networks enlarges the possibility of a stagflationary environment, largely dismissed by the consensus.
And the commanding risk is the economic structure of the Philippine economy depends on the assumption of the eternity of zero-bound rates. (Figure 6, lowest window)
This hard-core belief is about to be challenged soon.
Yours in Liberty,
The Prudent Investor Newsletters
No comments:
Post a Comment