Economy

Economists are betting that supply chains for all kinds of goods will heal, shortages will ease and price gains will slow. Cars are a wild card in those forecasts.Corina Diehl is eager for more sedans and pickup trucks to sell her customers in and around the Pittsburgh area, but as the pandemic enters its third year, cars remain in short supply and the squeeze on inventory shows no sign of abating.“If I could get 100 Toyotas today, I would sell 100 Toyotas today,” Ms. Diehl said. Instead, she said, she’s lucky to have three. “It’s the same with every brand I have.”Dealerships like Ms. Diehl’s are wrestling with inventory shortages — the result of a dearth of computer chips, production disruptions and other supply chain snarls. That’s not a problem just for car buyers, who are paying more; it’s also a problem for economic policymakers as they try to wrestle the fastest inflation in four decades under control.Car prices have helped push inflation sharply higher over the past year, and economists have been counting on them to level off and even decline in 2022, allowing the rising Consumer Price Index to moderate markedly.Rapid Car Inflation Year-over-year change in select automotive categories of the Consumer Price Index

Source: Bureau of Labor Statistics, accessed via FREDBy The New York TimesBut it is increasingly unclear how much and how quickly car prices will slow their ascent, because of repeated setbacks that threaten to keep the market under pressure. While price increases are showing some early signs of slowing and used car costs, in particular, are unlikely to climb at the same breakneck pace as last year, continued shortfalls of new vehicles could keep prices elevated — even rising — longer than many economists expected.“We’ve stumbled into another pattern of a series of unfortunate events,” said Jonathan Smoke, the chief economist at Cox Automotive, an industry consulting firm. Shutdowns meant to contain the coronavirus in China, computer chip factory disruptions tied to a recent earthquake in Japan, the aftereffects of the trucker strike in Canada and the war in Ukraine are adding up to slow production.Mr. Smoke expects new car prices to keep rising this year — perhaps even at nearly the same pace as last year — and used cars to begin to depreciate again, but said the shortage of new cars could spill over to blunt that weakening. And used cars may not fall in price at all if rental companies begin to snap them up as they did in 2021.“If the supply situation gets worse, it’s still possible that we repeat some of what we had last year,” he said.Mr. Smoke’s predictions — and worries — are more grim than what many economists are penciling into their forecasts.Alan Detmeister, a senior economist at UBS and former chief of the Federal Reserve Board’s wages and prices section, said he expected a 15 percent decline in used car prices by the end of the year, with new car prices falling 2.5 to 3 percent.Those estimates are predicated on an increase in supply.“This is a huge wild card in the forecast,” Mr. Detmeister said. But even if production doesn’t pick up, “it is extremely unlikely that we’ll see the kind of increases we saw last year,” he added, referring to prices.Omair Sharif, founder of Inflation Insights, a research firm, said he was still expecting improved supply and slower demand to help the used car market come into balance. While used car prices may rise for a few months as households spend tax refunds on automobiles, he expects the increase to be modest in part because they already nearly match new car prices.“I would be shocked if the used car market really accelerated,” he said. New car prices are a more complicated story, he added: “There, we have legitimately serious inventory problems.”Automakers are struggling to ramp up production. Russia’s invasion of Ukraine has created shortages in electrical components needed for cars, prompting S&P Global Mobility to cut its 2022 and 2023 forecasts for U.S. production. More critically, the chips needed to power everything from dashboards to diagnostics remain in short supply. Ford Motor and General Motors temporarily shut down some U.S. factories last week because of supply issues, and the industry broadly cannot ship as many cars as customers want to buy.In cars, “production remains below prepandemic levels, and an expected sharp decline in prices has been repeatedly postponed,” Jerome H. Powell, the Fed chair, said during a speech last month. He noted that while supply chain relief in general seemed likely to come over time, the timing and scope were uncertain.Cars loaded in Kansas City, Kan., for transport to a dealership in Wichita, Kan. Automakers are struggling to ramp up production as repeated shocks rock the industry.Chase Castor for The New York TimesAnalysts had been hoping that chip shortages, in particular, would ease up, but “we’ve got at least another year, if not more,” for the supply chain to heal, said Chris Richard, a principal in the supply chain and network operations practice at the consulting firm Deloitte.While smaller electronics producers may be able to find enough semiconductors, he said, cars contain hundreds or even thousands of chips — often different kinds — and many auto companies do not have direct and close relationships with their providers.The earthquake in Japan temporarily shut down chip plants that supply the auto industry, costing a few weeks of production at one. Making chips requires neon, and much of it comes from Ukraine. Lockdowns in Shanghai may reduce chip production at some Chinese factories.At the same time, demand is booming. Ford reported record retail vehicle orders in March, including for its F-series trucks, which remained in demand even as gas prices jumped.Car buying could begin to slow as the Fed raises interest rates, making car loans more expensive, but so far there is little sign that is happening. In fact, demand has been so strong that automakers have been cracking down on dealers that charge above list price, threatening to withhold fresh inventory.“I don’t see the prices subsiding. You don’t need them to subside,” said Joseph McCabe at AutoForecast Solutions, an industry analyst, explaining that dealer costs are increasing and companies want to protect their profits. “Prices will go up, and there will be less negotiating space for consumers, because there’s high demand and no availability.”Mr. McCabe does not think that car inventory will ever fully rebound: Dealers and automakers have learned that they make more money by effectively making cars to order and running with learner inventory. If that’s the case, the permanently restrained supply could have implications for the rental and used car markets.If car prices keep climbing briskly, it will be hard for inflation overall to moderate as much as economists expect — to around 4 to 4.5 percent as measured by the Consumer Price Index by the end of the year, according to a Bloomberg survey, down from 7.9 percent in February.That’s because prices for services, which make up 60 percent of the index, are also climbing robustly. They increased 4.8 percent in the 12 months through February, and could remain high or even continue to rise as labor shortages bite.Of the goods that make up the other 40 percent of the index, food and energy account for about half. Both have recently become markedly more expensive and, unless trends change, seem likely to contribute to high inflation this year. That puts the onus for cooling inflation on the products that make up the remainder of the index, like cars, clothing, appliances and furniture.While the Fed’s policy changes could tamp down demand and eventually slow prices, policymakers and economists had been hoping they would get some natural help as supply chains for cars and other goods worked themselves out.“We still expect some deflation in goods,” Laura Rosner-Warburton, an economist at MacroPolicy Perspectives, said of her forecast. She said that she expected fuel prices to moderate, and that her call included some “modest declines” in vehicle prices.It’s not just economists who are hoping that forecasts for a rebounding supply and more moderate car prices come true. Buyers and dealers are desperate for more vehicles. Ms. Diehl in Pittsburgh sells makes including Toyota, Volkswagen, Hyundai and Chevrolet, and companies have told her that inventory may begin to recover toward the end of the year — a reprieve that seems far away.Her customers are hungry for trucks, electric vehicles and whatever else she can get her hands on. When one of her dealerships lists a new car on its website in the evening, a buyer will show up first thing in the morning, she said. Her dealerships have a backlog of 400 to 500 parts to fix cars, up from 10 to 20 before the pandemic.“It’s absolute insanity at its finest,” Ms. Diehl said. “I don’t see an abundance of inventory before 2023 and 2024.” More

Has the surge in US consumer prices accelerated further? US inflation is expected to have hit another 40-year high in March. Consumer price index data, due out on Thursday, are forecast to have risen by 8.4 per cent year over year, according to estimates from Bloomberg, the fastest pace since 1981. The rate of price growth is up from 7.9 per cent in February, when the war in Ukraine was just beginning. Since then, prices of commodities have risen, with Brent crude, the international oil benchmark, rising to its highest level since 2008. While oil prices have backed off since that peak, they remain elevated, pushing up consumer prices.The measure of consumer prices that excludes the volatile food and energy sectors, so-called core CPI, is also expected to rise but at a much slower pace. Core CPI in February increased 6.4 per cent from the same month last year. The gauge is forecast to have risen 6.6 per cent in March, a fresh four-decade high, but the slowest increase in year over year growth since last summer. The gap between headline and core CPI points to a growing problem for the Federal Reserve. Inflation produced by supply chain bottlenecks or sanctions on Russia is not within the Fed’s direct control, but will nevertheless produce a higher headline number. That could prompt calls for evermore aggressive policy.“I think we can expect a growing divide between headline and core [CPI]. The risk is that this keeps the Fed needing to surprise the market on the hawkish side just to catch up to inflation risks,” said Jim Caron, a portfolio manager at Morgan Stanley. Kate DuguidHow much have rising energy prices pushed up UK inflation?Like the US, the UK has also faced record price growth in recent months. Annual inflation reached a 30-year high of 6.2 per cent in February, before Russia’s invasion of Ukraine sent energy prices even higher. Economists polled by Reuters expect March data, released on Wednesday, to show that consumer price growth accelerated to 6.7 per cent on an annual basis as pressures become more widespread across the economy. Many economists expect inflation to surge further in April, to around 8 per cent, after the energy regulator authorised a higher cap on prices. Silvia Dall’Angelo, economist at Federated Hermes International said: “Going forward, headline inflation is set to rise further, mainly reflecting a large increase in international oil prices, large adjustment to utility prices in April and October and, more generally, the impact from high commodity prices.”The limit on energy bills is expected to rise by a further 40 per cent in October, which would add to inflationary pressure. The Office for Budget Responsibility, the UK fiscal watchdog, expects consumer price growth to peak at close to 9 per cent in the fourth quarter of this year, double the rate of its previous forecast and the highest inflation rate in about 40 years.The OBR said soaring prices were largely driven by higher energy costs, but “excess demand in the domestic economy means we expect that much of these cost increases will be passed on to consumer prices and will be partly matched with higher nominal wage growth”. That could mean a more prolonged period of high inflation than currently expected. Valentina RomeiWill the ECB speed up monetary tightening? The governing council of the European Central Bank will meet in Frankfurt on Thursday with its members being pulled into two competingdirections on eurozone monetary policy.The more ‘hawkish’ officials argue the surge in eurozone inflation to a record 7.5 per cent in March means they should accelerate the ECB’s plans to end net bond-buying and quickly raise interest rates for the first time in over a decade.But an opposing camp of council members are pushing back, saying a rate increase would come at the worst time for the eurozone economy, which is already facing a downturn due to the war in Ukraine, especially if Russian gas supplies to Europe are suddenly cut off because of the conflict. “Looming stagflation in the eurozone has complicated the ECB’s life,” said Carsten Brzeski, head of macro research at ING. “Higher inflation for longer and a very uncertain outlook for growth not only in theshort but also longer-term will worsen the ongoing controversy between ECB [policymakers].”Contrasting statements from ECB officials last week highlighted the divergence of opinion at the top of the central bank. German central bank president Joachim Nagel said soaring inflation “worries us all” and predicted “savers may soon be able to look forward to higher interest rates again”.Hours earlier, ECB executive board member Fabio Panetta said most price pressures came from energy markets and other factors outside the central bank’s control, so it would “have to massively suppress domestic demand to bring down inflation”.Analysts expect the ECB is likely to stick to its plans for ending net bond purchases in the third quarter, and to say it will keep its options open for speeding up or slowing down the withdrawal of stimulus, depending on how the economy responds in the coming months. Martin Arnold More

COLOMBO (Reuters) – Sri Lanka will need about $3 billion in external assistance within the next six months to help restore supplies of essential items, including fuel and medicines, to manage a severe economic crisis, its finance minister told Reuters on Saturday.The island nation of 22 million people has been hit by prolonged power cuts, with drugs, fuel and other items running short, bringing angry protesters out on the streets and putting President Gotabaya Rajapaksa under mounting pressure.”It’s a Herculean task,” Finance Minister Ali Sabry said in his first interview since taking office this week, referring to finding $3 billion in bridge financing as the country readied for negotiations with the International Monetary Fund (IMF) this month.The South Asian island nation will look to restructure international sovereign bonds and seek a moratorium on payments, and is confident of negotiating with bondholders for an upcoming $1 billion payment in July.”The entire effort is not to go for a hard default,” Sabry said. “We understand the consequences of a hard default.”J.P. Morgan analysts estimated this week that Sri Lanka’s gross debt servicing would amount to $7 billion this year, with the current account deficit coming in around $3 billion.The country has $12.55 billion in outstanding international sovereign bonds, according to central bank data, and foreign reserves of $1.93 billion at the end of March.”The first priority is to see that we get back to the normal supply channel in terms of fuel, gas, drugs… and thereby electricity so that the people’s uprising can be addressed,” Sabry said.’SENSE OF CONFIDENCE’Anti-government protests have raged across the island for days, with at least one turning violent in the country’s commercial capital of Colombo, which have hurt the lucrative tourism industry that was ravaged by the COVID-19 pandemic.”We respect your right to protest, but no violence, because it is counterproductive,” Sabry said.”Our tourism, which was beautifully coming back in February with 140,000 tourists coming in, has been severely affected ever since the demonstrations.”Sabry said he will lead a delegation of Sri Lankan officials to Washington to start talks with the IMF on April 18 and that financial and legal advisers would be selected within 21 days to help the government restructure its international debt.”Once we go to them, first thing is there is a sense of confidence in the entire international monetary community that we are serious,” he said. “We are transparent, we are willing to engage.”On Friday, a new central bank governor raised interest rates by an unprecedented 700 basis points in a bid to tame rocketing inflation and stabilise the economy.Sri Lankan authorities will also reach out to rating agencies, Sabry said, as the country looks to regain access to international financial markets after being locked out due to multiple ratings downgrades since 2020.Sabry said the government will hike taxes and fuel prices within six months and seek to reform loss-making state-owned enterprises, in an effort to fix public finances.These measures were among key recommendations in an IMF review of Sri Lanka’s economy released in early March.”These are very unpopular measures, but these are things we need to do for the country to come out of this,” Sabry said. “But the choice is do you do that or do you go down the drain permanently?”‘FRIEND OF ALL’Sri Lanka will seek another $500 million credit line from India for fuel, which would suffice for about five weeks of requirements, Sabry said.The government would also look for support from the Asian Development Bank, the World Bank and bilateral partners including China, the United States, Britain and countries in the Middle East.”We know where we are, and the only thing is to fight back,” Sabry said, looking relaxed in a blue T-shirt and jeans. “We have no choice.”Discussions are ongoing with China on a $1.5 billion credit line, a syndicated loan of up to $1 billion dollars and a request from Sri Lanka’s president in January to restructure some debt.”Hopefully we will be able to get some relief and which would help to keep the Sri Lanka community and the country afloat until larger infusions come in,” Sabry said.Beijing and New Delhi have long jostled for influence over the strategically located island off India’s southern tip, with the country pulling closer to China under the powerful Rajapaksa family.But in recent weeks, as the economic crisis deepened, Sri Lanka has leaned heavily on assistance from India.”We are a neutral country. We are friend of all,” said Sabry, a lawyer who previously served as Sri Lanka’s justice minister. “So we think that goodwill will come in handy at this point in time.” More

To learn more about the CNBC CFO Council, visit cnbccouncils.com/cfo-council/

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American consumers are already cutting back on spending, according to a new CNBC survey.
For many living paycheck to paycheck, this is not a surprise as inflation rises and Covid stimulus savings decline.
However, the survey also shows that higher-income consumers are showing signs of financial stress and have begun cutting back on dining out, travel and vacations, and cars.

Miami, Florida, Brickell City Centre shopping mall with Apple Store, Chanel and escalators.
Jeff Greenberg | Universal Images Group | Getty Images

With as much as 60% of U.S. consumers living paycheck to paycheck, it’s not a surprise to see that the spending cutbacks have started. Even with a strong job market and wage gains, as well as Covid stimulus savings, pricing spikes in core spending categories including food, gas and shelter are leading more Americans to mind their pocketbooks closely.
A new survey from CNBC and Momentive finds rising concerns about inflation and the risk of recession, and Americans saying not only have started buying less but will be buying less across more categories if inflation persists. But these financial stress points are not limited to lower-income consumers. The survey finds American with incomes of at least $100,000 saying they’ve cut back on spending, or may soon do so, in numbers that are not far off the decisions being made by lower-income groups.

The high-income consumer demographic is key to the economy. While it represents only one-third of consumers, it is responsible for up to three-quarters of the spending. As Mark Zandi, chief economist at Moody’s notes, “If the high-income consumers are out buying, we won’t see a big impact on raw consumer activity.”

Arrows pointing outwards

Lower-income households are the most at risk, and they are the ones most likely to be making unwelcome tradeoffs to make their money stretch as far as it did just a few months ago, according to the survey results. They are also clearly experiencing more financial anxiety, according to the survey, with 57% of Americans with income under $50,000 saying they are under more stress than a year ago, versus 45% of those with incomes of $100,000 or more. The 68% of high-income consumers who said they are worried higher prices will force them to rethink financial decisions is significantly lower than the 82% of Americans with income of $50,000 or less who told the survey this, but it is still a majority.

More than half of people with household incomes under $50,000 say they have already cut back on multiple expenses due to prices, and for those with income of at least $100,000, the cutback levels are already similar when it comes to dining out, taking vacations, and buying a car.
“People making six-figure incomes are almost as worried about inflation as people making half as much —and they are just as likely to be taking steps to mitigate its effect on their lives,” said Laura Wronski, senior manager of research science at Momentive. “Inflation is a problem that compounds over time, and even high-income individuals won’t be insulated from the second- and third-order effects of price increases,” she said.

Arrows pointing outwards

Other recent consumer survey data paints a weakening picture.

The University of Michigan Survey of Consumers finds more consumers mentioning reduced living standards due to rising inflation than at any other time in the survey’s history except during the two worst recessions in the past 50 years: from March 1979 to April 1981 and from May to October 2008. Notably, the consumer confidence gap between low and high income levels always shrinks at cyclical troughs and is always widest at peak, and the gap is narrowing now, according to survey director Richard Curtin. 
In January, the percentage point gap between the lowest income and highest income group in the survey’s sentiment index was 13.2 points. That was erased in March, with the top income group sentiment actually dipping below the lowest income bracket in overall sentiment and future expectations. In January, the higher income group expectations, specifically, were 18 percentage points higher.
Right now, there is a unique set of issues that could be exacerbating this gap narrowing, Curtin said, including the potential for Russia’s invasion of Ukraine to do more damage to the global economy than forecast and the fact that the majority of the population has not experienced 10%+ inflation, or 15% mortgage rates, as past generations had.
“Even at lower rates they may display behaviors associated with more extreme economic conditions in the past,” Curtin said. “Precautionary motives play a big part in consumption trends for upper income groups,” he added.

Arrows pointing outwards

“The American consumer is in a dark mood,” Zandi said of the CNBC survey data. More than two years since the pandemic hit, first with millions of lost jobs and high unemployment, and now high inflation, and “fractured politics also weighing heavily on the collective psyche.”
All income groups in the survey are equally likely to say the economy will enter a recession this year, at over 80%. But there is a key caveat: actual spending actions from the economy don’t yet indicate this prediction will come true.
Despite the downbeat feelings about their financial situations, and cutbacks, Zandi stressed that consumers are still spending strongly. There are now lots of jobs, unemployment is low, debt loads are light, asset prices are high, and there is a lot of excess saving. Even if people are cutting back, spending less on some items, the mood has not yet taken control of the spending motivation to a degree that amounts to more than a slowdown in economic growth. “I suspect the American consumer will continue spending, regardless of their mood, as long as the job market remains strong,” Zandi said.

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The Conference Board’s latest monthly confidence index reading showed present confidence up (slightly) for the first time this year, but the expectations index lower, with consumers citing rising prices, including gas.
Lynn Franco, director of economic indicators and surveys at The Conference Board, said there is still a gap in its confidence data between lower income and higher income consumers and a lot of that is driven by the inflationary environment, and less impact the affluent will feel from factors including gas prices. She said the gap does always narrow in a pre-recession period — but its data is not indicating a recession as of now.
What its confidence survey is forecasting is a slowdown in growth over the next few quarters driven by higher prices, and more Americans spending less on discretionary items as more of their money goes to covering the basics. That will be most acutely felt by the lower-income consumers, but there is broad-based concern about prices rising significantly in the months ahead — 6 out of every 10 consumers surveyed by The Conference Board think the Russia-Ukraine war will cause prices to rise significantly.
“That is very broad-based and that, coupled with interest rates going up, may make people more hesitant to postpone big-ticket purchases likes housing and autos and washing machines,” Franco said. “We will see a bit of slowing in consumer spending over the next few quarters, but we don’t feel that will drive us into recession.”
The overall confidence level from Americans with income of $125,000 in its survey has come back down from mid-2021, but Franco described them as still “relatively confident despite all volatility we have seen. … The indications we are getting across income groups speaks more towards softening in consumer spending rather than a severe pullback,” she said.
The Conference Board data, similar to other outlooks, is underpinned by a key role for the labor market in supporting confidence and balancing the negative influence of inflation, with Americans who say jobs are “plentiful” at an all-time high. 

More from the CNBC | Momentive consumer survey

Members of the CNBC CFO Council have mentioned “a tale of two cities” among consumers, with higher income bracket consumers continuing to be strong while lower income consumers are beginning to chew through the stimulus. There will be a new equilibrium point, and inflation won’t grow as it has over the past year, but it will remain at a higher level, and the consumer spending has to be set against this dynamic that will play out through calendar year 2022, and is expected to be more sharply felt in the second half of the year.
Key factors that CFOs are watching include the decline in the consumer savings rate; how successful the Fed is in using its tools to slow the economy without pushing it into recession, including raising rates to cool consumption and investment; and greater supply chain stability.
The supply chain remains in flux with new Covid variants, as well as the Russian war against Ukraine hitting energy and food prices. But if supply chain pressures overall do ease, inventory will be replenished at a rate that could lead to more pushback from retailers on pricing, as consumers also begin to slow down consumption habits, trading down in certain categories of purchases or trading away from them.
The Conference Board’s most recent CEO survey showed that companies are passing along the costs of inflation relatively quickly to consumers, and that pattern is likely to continue in the months ahead, with wage gains a contributing factor. “What we are seeing and hearing from members is that these tight labor market conditions are going to continue for several months, so we will continue to see wage pressure,” Franco said.
As earnings come in, the market will be looking for signs of durable consumer strength amid higher prices. Earlier this week, Conagra’s results showed that it couldn’t make price increases flow through to its bottom line relative to input costs, but CEO Sean Connolly said on Thursday that “consumer demand has remained strong in the face of our pricing actions to date.”
Conagra is planning more price increases. More

Federal Reserve policymakers are going to try to slow down the economy and subdue inflation.
Higher rates make money costlier and borrowing less appealing. That, in turn, slows demand to catch up with supply, which has lagged badly throughout the pandemic.
Fed officials also have talked tough on inflation, in an effort to dampen future expectations.
Potential effects include lower wages, a halt or even a drop in home prices and a decline in stock market valuations.

A customer shops at at a grocery store on February 10, 2022 in Miami, Florida. The Labor Department announced that consumer prices jumped 7.5% last month compared with 12 months earlier, the steepest year-over-year increase since February 1982.
Joe Raedle | Getty Images

The view that higher interest rates help stamp out inflation is essentially an article of faith, based on long-held economic gospel of supply and demand.
But how does it really work? And will it work this time around, when bloated prices seem at least partially beyond the reach of conventional monetary policy?

It is this dilemma that has Wall Street confused and markets volatile.
In normal times, the Federal Reserve is seen as the cavalry coming into quell soaring prices. But this time, the central bank is going to need some help.
“Can the Fed bring down inflation on their own? I think the answer is ‘no,'” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “They certainly can help rein in the demand side by higher interest rates. But it’s not going to unload container ships, it’s not going to reopen production capacity in China, it’s not going to hire the long-haul truckers we need to get things across the country.”
Still, policymakers are going to try to slow down the economy and subdue inflation.
The approach is two-pronged: The central bank will raise benchmark short-term interest rates while also reducing the more than $8 trillion in bonds it has accumulated over the years to help keep money flowing through the economy.

Under the Fed blueprint, the transmission from those actions into lower inflation goes something like this:
The higher rates make money costlier and borrowing less appealing. That, in turn, slows demand to catch up with supply, which has lagged badly throughout the pandemic. Less demand means merchants will be under pressure to cut prices to lure people to buy their products.

Potential effects include lower wages, a halt or even a drop in soaring home prices and, yes, a decline in valuations for a stock market that has thus far held up fairly well in the face of soaring inflation and the fallout from the war in Ukraine.
“The Fed has been reasonably successful in convincing markets that they have their eye on the ball, and long-term inflation expectations have been held in check,” Baird said. “As we look forward, that will continue to be the primary focus. It’s something that we’re watching very closely, to make sure that investors don’t lose faith in [the central bank’s] ability to keep a lid on long-term inflation.”
Consumer inflation rose at a 7.9% annual pace in February and probably surged at an even faster pace in March. Gasoline prices jumped 38% during the 12-month period, while food rose 7.9% and shelter costs were up 4.7%, according to the Labor Department.

The expectations game

There’s also a psychological factor in the equation: Inflation is thought to be something of a self-fulfilling prophecy. When the public thinks the cost of living will be higher, they adjust their behavior accordingly. Businesses boost the prices they charge and workers demand better wages. That rinse-and-repeat cycle can potentially drive inflation even higher.
That’s why Fed officials not only have approved their first rate hike in more than three years, but they also have talked tough on inflation, in an effort to dampen future expectations.
In that vein, Fed Governor Lael Brainard — long a proponent of lower rates — delivered a speech Tuesday that stunned markets when she said policy needs to get a lot tighter.
It’s a combination of these approaches — tangible moves on policy rates, plus “forward guidance” on where things are headed — that the Fed hopes will bring down inflation.
“They do need to slow growth,” said Mark Zandi, chief economist at Moody’s Analytics. “If they take a little bit of the steam out of the equity market and credit spreads widen and underwriting standards get a little tighter and housing-price growth slows, all those things will contribute to a slowing in the growth in demand. That’s a key part of what they’re trying to do here, trying to get financial conditions to tighten up a bit so that demand growth slows and the economy will moderate.”
Financial conditions by historical standards are currently considered loose, though getting tighter.

Indeed, there are a lot of moving parts, and policymakers’ biggest fear is that in tamping down inflation they don’t bring the rest of the economy down at the same time.
“They need a little bit of luck here. If they get it I think they’ll be able to pull it off,” Zandi said. “If they do, inflation will moderate as supply-side problems abate and demand growth slows. If they’re unable to keep inflation expectations tethered, then no, we’re going into a stagflation scenario and they’re going to need to pull the economy into a recession.”
(Worth noting: Some at the Fed don’t believe expectations matter. This widely discussed white paper by one of the central bank’s own economists in 2021 expressed doubt about the impact, saying the belief rests on “extremely shaky foundations.”)

Shades of Volcker

People around during the last serious bout of stagflation, in the late 1970s and early 1980s, remember that impact well. Faced with runaway prices, then-Fed Chair Paul Volcker spearheaded an effort to jack up the fed funds rate to nearly 20%, plunging the economy into a recession before taming the inflation beast.
Needless to say, Fed officials want to avoid a Volcker-like scenario. But after months of insisting that inflation was “transitory,” a late-to-the-party central bank is forced now to tighten quickly.
“Whether or not what they’ve got plotted out is enough, we will find out in time,” Paul McCulley, former chief economist at bond giant Pimco and now a senior fellow at Cornell, told CNBC in a Wednesday interview. “What they’re telling us is, if it’s not enough we will do more, which is implicitly recognizing that they will increase downside risks for the economy. But they are having their Volcker moment.”

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To be sure, odds of a recession appear low for now, even with the momentary yield curve inversion that often portends downturns.
One of the most widely held beliefs is that employment, and specifically the demand for workers, is just too strong to generate a recession. There are about 5 million more job openings now than there is available labor, according to the Labor Department, reflecting one of the tightest jobs markets in history.
But that situation is contributing to surging wages, which were up 5.6% from a year ago in March. Goldman Sachs economists say the jobs gap is a situation the Fed must address or risk persistent inflation. The firm said the Fed may need to take gross domestic product growth down to the 1%-1.5% annual range to slow the jobs market, which implies an even higher policy rate than the markets are currency pricing — and less wiggle room for the economy to tip into at least a shallow downturn.

‘That’s where you get recession’

So it’s a delicate balance for the Fed as it tries to use its monetary arsenal to bring down prices.
Joseph LaVorgna, chief economist for the Americas at Natixis, is worried that a wobbly growth picture now could test the Fed’s resolve.
“Outside of recession, you’re not going to get inflation down,” said LaVorgna, who was chief economist at the National Economic Council under former President Donald Trump. “It’s very easy for the Fed to talk tough now. But if you go a few more hikes and all of a sudden the employment picture shows weakness, is the Fed really going to keep talking tough?”
LaVorgna is watching the steady growth of prices that are not subject to economic cycles and are rising just as quickly as cyclical products. They also may not be as subject to the pressure from interest rates and are rising for reasons not tied to loose policy.
“If you think about inflation, you have to slow demand,” he said. “Now we’ve got a supply component to it. They can’t do anything about supply, that’s why they may have to compress demand more than they normally would. That’s where you get recession.”

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Trust is in diminishing supply around the world. That is true among nations, business counterparts and securities traders. In the markets we can measure this distrust in the differing prices of similar financial assets ultimately backed by the US Federal Government. Take, for example, the interest rate paid by the Federal Reserve to banks who park their money nearly risk-free overnight in its “Reverse Repurchase Facility”. The Fed has engaged in reverse repos for years, under which it would receive cash overnight, secured by the highest quality short term securities, in exchange for “reserves”, a sort of non transferable asset for financial institutions. But institutions and investors have other low-risk options for their spare cash, such as short term Treasury bills. In fact, a curiously persistent gap has appeared between the interest rates on the shortest term T-bill rates and the periodically reset rates offered by the RRP.As an example, on March 23rd, the four week Treasury bill at one point yielded about 13 basis points (each one 100th of a percentage point), while the RRP offered 30 bps. In the past, markets have not priced in much difference between them.If this spread happened because of an oddball event — a massive one day computer failure perhaps — it might be considered just noise, not a signal. Yet this difference has persisted fairly consistently since June of last year. Both the RRP and the T-bills offer daily liquidity, and the full faith of the Federal Government sits behind both. So why these yield divergences? Part of the idea behind the RRP concept was to assure money market funds held by bank customers and corporations that they would always get a low-ish, but at least positive interest rate on the cash in these safe RRP accounts. Assuring this sense of safety for account holders was paramount. Without this protection public confidence in the system as a whole would be shaken.The underlying problem was that banks and other deposit-takers, such as the money market funds, had not found enough sound lending or investing opportunities for excess cash made available by the quantitative easing programmes. From the beginning of the pandemic in early 2020, US loan demand weakened so that deposits from the banks’ customers could not be put to work as in the normal banking model.The regular use of the “RRP” began only in 2014, and for a while the Fed (and its customers) only used it as required. But the repurchasing facility has grown in importance, especially in the last two years. On a daily basis, no participant in the RRP can bid for less than $1 million, or more than $160 billion.The facility has become more popular with institutions which daily end up with more cash than attractive, short term low-risk opportunities. On April 4 of this year, for example, overnight RRPs amounted to $1.73tn. So given the Fed’s backing of this type of account, why are people willing to pay up for short term T-bills (and get less yield) when they might earn twice as much using the RRP? The big reason, in my view, is that those T-bills can be more useful. An investor or a dealer-bank, after purchasing them, can lend and re-lend these securities several times each before they mature. This is a process sometimes known as “re-hypothecating”.

Each time an institution that holds the bills lends them out it can receive a “securities lending fee”. The flexibility of these T-bills to provide collateral security makes them popular instruments for use in typical fixed income market transactions. Interest rate swaps, where two parties exchange different income streams paid over different time periods, might have T-bills used as a collateral in the transaction. In contrast, while the RRP may offer a higher rate, unlike T-bills they are not instruments which can be re-lent. This “collateral market” is a vital, under-reported, aspect of the international financial system. Manmohan Singh, senior financial economist at the IMF, is the leading expert on the topic. His research has shown how use of collateral can give an indication of market health.When financial market participants have a great deal of confidence in each other, the “collateral re-use rate”, or the number of times T-bills (or perhaps short term German Bunds) are lent and re-lent, increases. In the easier days of 2007, a short term T-bill might be re-used as much as three times. By 2016, the re-use rate (a sort of inverse measure of trust) had dropped to 1.8 times. In recent years, collateral re-use has picked up again.Now, though, the continuing interest rate gap between the RRP and short term bills tells us there is a new scramble for access to the best collateral. That suggests financial counterparties trust each other and their asset quality less and less. More

Around the turn of the century, currency traders, hedge funds and heavy-hitting economists obsessed over central banks’ foreign exchange reserves.The euro was a baby, and backers faced a daunting task raising it as a currency with global impact, enmeshed in international trade and investment. Any data suggesting it was eating into the dollar’s dominance in global central banks’ coffers was taken as a sign of progress towards that aim, and produced abrupt shifts in the euro’s exchange rate. It was an obsession, not without foundation, that proved lasting. In the Greek debt crisis that peaked in 2012, one of the reasons behind shouty (and faulty) predictions that the euro would drop below parity against the dollar was that central bank reserve managers could lose faith in the legal and political framework behind the European currency, and eject it from their rainy-day reserves.Central bank reserve diversification became a go-to explanation for any hard-to-fathom intraday currency move. Euro picking up? Ask a trader and he (it was invariably “he”) would often tell you “Boris” (ie Russia) or another central bank was buying. Or maybe China was nixing dollars from its reserves.Russia’s invasion of Ukraine brings this market preoccupation, which had laid largely dormant for several years, back to the fore. The US, in its effort to punish Russia for the Ukraine conflict, has made spectacular use of its “exorbitant privilege”, as Valéry Giscard d’Estaing, the former French president and finance minister, controversially put it in the 1960s.As the dollar-baiters of two decades ago frequently observed, the global role of the dollar, its outsized share in world trade and its dominance of financial markets, confers enormous power on the US to use sanctions to bend geopolitics to its will. Now, you can argue over whether that is appropriate. What if a less predictable White House were in future to use this privilege in much more contentious cases? Should any country have this power to use money as a weapon?Decent questions. But in the market’s view, what matters is that sanctions by the US and its allies on Russia’s central bank will prompt other countries that are not geopolitically aligned with the US to rethink holding so many bucks on their books.Goldman Sachs’ currency analysts said “the result could be dollar depreciation”, adding that they had seen “lots of client interest” in this theme. It is one into which hedge funds could really sink their teeth.Then again, the US investment bank warns against getting overly excited. “We should stress that the structure of currency markets will not change overnight, and there are many interrelated reasons why the dollar maintains its dominant global role,” it said.

There’s another reason not to bet the farm on an imminent dollar collapse: the US did not freeze Russia’s reserves on its own. Officials involved in crafting the sanctions against Russia knew they would work best in conjunction with the EU, UK and other G7 nations. So, sure, Moscow, or another prickly regime, can in future shy away from dollars, but go where instead? Russia cannot shift to euros, sterling or yen given that payment sanctions extend to those as well. It could eschew them all, but then its funds for buying essentials or defending the rouble would all be in currencies with limited international use. In addition, opting for the renminbi to avoid politically motivated freezes seems rather naive.Still, the potential for this to diminish the dollar’s reserve status is real. The implications are potentially profound and could take years to become fully clear. Gita Gopinath, deputy managing director at the IMF, has spoken of the potential that the global financial system could “fragment”. Previous market fixations on this issue suggest that, despite the tectonic pace of change, traders will keenly spot short-term opportunities.An IMF study last month, addressing the “stealth erosion of dollar dominance”, offers clues to where those opportunities lie. The dollar’s place in international reserves has clearly shrunk since the turn of the century, from 71 per cent in 1999 to 59 per cent in 2021, the IMF said, reflecting “active portfolio diversification” by central banks.Intriguingly, the share of reserves in the other “Big Four” currencies — sterling, the yen and the euro — has not picked up the slack. “Rather, the shift out of dollars has been in two directions: a quarter into the Chinese renminbi, and three-quarters into the currencies of smaller countries that have played a more limited role as reserve currencies,” the IMF said.More availability of easy-to-trade assets and slicker trading technology have made it easier to snap up Australian and Canadian dollars, the Chinese renminbi and a clutch of Nordic currencies.“Reserve currency competition is usually framed as a battle of giants,” the IMF said. In fact, the issue is not whether the dollar will be replaced, but whether smaller currencies take a bigger slice of the pie. The next time a small currency jumps for no obvious reason, expect this to be offered as the explanation. More

By Ana ManoSAO PAULO (Reuters) – The Biden administration is not doing enough to forge a long-term alliance with Brazil, Myron Brilliant, the U.S. Chamber of Commerce’s head of the international affairs division, told a press conference in Sao Paulo on Thursday. “In my candid view, I don’t think the Biden administration is doing enough to focus on this region,” he said of the world’s ninth largest economy, adding part of the reason is the U.S. domestic agenda. Brilliant said the lack of U.S. engagement across Latin America means “opportunities are not developed (nor is a) long-term strategic plan in the way that we would hope.”The absence of the U.S. has paved the way for other partners to liaise and do business with Brazil.”What we have seen in the last decade is a significant rise of Chinese investment and engagement in the region,” Brilliant said. “We are also seeing Russian engagement. We would say that the U.S. has to be present.”The U.S. is Brazil’s second most important trade partner, behind China. The difference is that Brazil runs a trade surplus with the Asian country, and a deficit with the U.S.Brazil and the U.S. compete as exporters of agriculture commodities like soy, meat and corn. In the first quarter of the year, Brazil ran a $3.8 billion trade deficit with the U.S. and $4.7 billion surplus with China, according to Brazilian government data. The U.S. accounted for about 11% of Brazil’s overall exports in the period while China was almost 28%, the data showed.”Defining trade in terms of deficit and surplus is a mistake,” Brilliant said. “Important for us is to have a level playing field.” More