The investing landscape has become an extraordinarily complex place. We’ve seen supply shocks that we haven’t seen since the 1970s, there’s been a pandemic, and everyone is scrambling to understand what’s going on. But the biggest issue right now is undoubtedly inflation. We are at inflation levels we haven’t seen since 1990, which has been hard to understand for many economists.
Much of the problem comes from a misunderstanding of inflation which isn’t properly captured in the CPI number. We’ll explore the implications of this in an upcoming blog. For now, let’s have a look at the recent slowdown in the pace of rate rises by the RBA.
Globally inflation remains well above central bank targets in most economies. And while the CPI numbers for July and August in Australia measured 7% and 6.8%, respectively, compared to a year earlier, the RBA sensibly slowed the pace of interest rate rises from 0.5% increases down to 0.25%. In the meeting minutes, it seems that the RBA has finally come around to our view that inflation is likely to peak later this year. This is all positive news for risk assets such as property and shares.
Much of this is due to the amount of demand and wealth destruction that has already occurred. At this point, around $50T has been wiped off asset prices globally, which is about double what was experienced in 2008. Having said this, the capital base is roughly twice the size – nevertheless, what we have witnessed already is similar to a GFC-level event in percentage terms.
We’ve also seen a sharp decline in shipping rates and commodities prices. In the real world, in our discussions with some of the biggest private developers in the country, most are saying that the prices of building materials have stabilised. Given the 6 to 12-month lag between rate changes and their effect on the economy, continuing to raise rates when we haven’t seen the impact of the ones already made would be foolish. The RBA is hoping for a Goldilocks situation of slowing the economy just enough to tame inflation while not sending us into recession. Whether or not they can achieve this remains to be seen. Regardless a recession would only accelerate the timing of the rate drops. One other thing to note is that even if prices stay flat, CPI will fall by next year simply because it will be divided by a higher denominator.
We’re living in a strange opposite world now, where bad news for the economy is good news for asset prices since they’re so heavily correlated to interest rates. Overall, our investment thesis hasn’t changed, with most of the big-picture drivers of inflation softening and pointing to the likelihood that we have already seen peak inflation in the real world.
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