[TOP STORY] US GDP still strong, but fears abound around inflation

‘Strange things are happening here’ – Dr Chris Harmse of CH Economics.

SIMON BROWN: I’m chatting now with Dr Chris Harmse, economist at CH Economics. Chris, I appreciate the early morning time. I was chatting there just for a moment with Nick Kunze. We were talking in a sense around the markets and the results that have been coming out of the US. They’ve been strong. If we move towards looking at the economic data, we saw US GDP really strong, but the fears are still around inflation, and we are officially in rate-rising season pretty much everywhere, with the US coming to the party in March.

CHRIS HARMSE: Simon, yes, that’s correct. We’ve seen sharp increases in the inflation rate across the world. If you take for instance in the US the inflation rate in one year, that increased from 0.5% to 7%. The same happened, of course, in Europe as well as in the UK where … the inflation rate more than triple and [it’s] still going up. It is our fear of a new cycle of interest-rate hikes.

SIMON BROWN: Typically the old school sort of investor in me says raising rates is tricky for markets. There is still a lot from sort of the fundamental side. The economic side of it that is out there is going to be perhaps putting a worry into markets, and hence the selling we’ve seen so far this year.

CHRIS HARMSE: Definitely. I think the three main economic events each month have led to this huge volatility and selloff, especially in the US. That is of course the monthly inflation data of the US that is just climbing and climbing. And then [there’s] the FOMC meeting of the Federal Reserve warning that they’re going to start to increase rates from March, and they’re going to stop buying back bonds in the market. And then the non-farm payrolls. Those three economic indicators – apart from your economic growth, retail sales and your purchasing managers index indices – we’ve seen have a huge effect and under our nose is very negative, especially on the Nasdaq. The Nasdaq from the beginning of the year has dropped by 12% – and that’s already an indication of a downward correction – [if] it’s over 10%. If you take the Standard & Poor’s it’s already down by 7%, and on Wall Street your Dow Industrial Index is down by 4.4% in the first four weeks.

It’s an indication, number one, of volatility, and number two of worries about the economic fundamentals, which may push share markets in a downward trend.

SIMON BROWN: Adding to that worry is that asset purchasing which the Fed has been doing since the pandemic started. It also did huge stimulus, which of course has exited the market now – but that certainly had an impact. We’ve now got that withdrawal of asset purchases which will be ending in March, which is I’ve got to say a lot sooner than I’d expected. That has huge potential. The markets have quite liked this kind of free money flooding in.

CHRIS HARMSE: Yeah, that was a free-for-all that earnings of companies have sought since they started with that buying back of bonds and assets in the market. That flourished last year and, because of the stimulation packages from a very low base, you had a large increase in economic activity, bottlenecks that appeared on the retail side. Then also of course your commodity prices increased very fast. Seeing that’s the end of that party with the only other worrying aspect, which we can compare with 2007/8, which led to the subprime crisis, is the sharp increase in the oil price. During that stage the oil price had increased from $25/barrel in two years to $125, and we see what was the reaction of interest rates across the world, where the US Fed – I think it increased their interest rates something like 16 times. So that’s another worrying effect.

There’s also the geopolitical problem of the Ukraine, which pushes up this oil price.

Read: Oil heads for best January in decades

So there are a lot of worrying aspects which will, of course, bombard the share prices. Even this week we still expect large volatility in the market waiting for the US non-farm payrolls.

SIMON BROWN: That is my sense of what we’re seeing here – that sort of the shift from what we’ve seen in the pandemic. Obviously we can say that we’re sort of starting to move beyond it, but we’ve got all at seven-and-a-half-year highs. We’ve got rising inflation at decade highs – 40-year highs in the case of the US rising interest rates. This is a whole different ball game for markets which we haven’t seen before. And it’s kind of, I suppose, ‘we’re not sure’.

CHRIS HARMSE: We are not sure. No. Just like we were not sure in 2007/2008. The new kid on the block was sub-prime and everyone said, wow, what is this story now? The post-pandemic is the same story. It’s uncertain terrain; will it still be old school? I still believe that the Fed is already behind. It should have increased interest rates already – like South Africa, in fact.

Read: Reserve Bank raises repo rate to 4%, as expected

The effect on the markets is different at this stage. With increasing interest rates last Thursday, one would have expected the rand to improve. The rand turned around on Friday and lost about 29 cents to R15.60/dollar this morning. We’ve seen the same effect on the financial markets. One would expect the financial index to take quite a hit on Friday due to the weaker rand. But the opposite happened. The financial index was one of the winners on Friday.

So strange things are happening here. But at this stage, especially in the US, there is huge volatility. In fact the Dow improved on Friday again by over 1.6%, and the Nasdaq improved by over 3%. So that’s huge volatility in one week.

SIMON BROWN: It is. And that volatility is directly due to that uncertainty range. We’ll leave it there. Dr Chris Harmse, economist at CH Economics, I appreciate the early morning.



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