Have we reached the end of the “Central Bank Put” cycle?

Mathan Somasundaram

Deep Data Analytics

The local market was hit hard after the US market copped a bashing on reflation worries. Tech led the bleeding by a distance, while miners were targeted selling on China tightening worries. Energy and healthcare were the only green sectors with geopolitics, pandemic and falling AUD/USD catalysts. The local budget is a classic election budget with weak to no credible assumptions. Expect an election in Sept or October, before data starts to crater. 

The Budget’s main drivers are:

  1. vaccine rollout that the government has botched and which is now behind due to supply issues 
  2. commodity prices, which are out of their control while geopolitics with China will raise risk
  3. tax cuts being funded by historic high debt loading in a cycle where the cost of borrowing is going to keep rising 
  4. inevitable tax rises to pay for underfunded health, education, aged care etc are being ignored 
  5. still no reform in numerous sectors with existing issues. 

Apart from that, everyone gets more handouts on an endless credit card and we live happily ever after. The budget overspending into the future and wasted commodity boom has a pre GFC feel. 

Banks are already starting to push up fixed rate home loans. All asset prices are going to face reality as US cycle turns. It’s an election cycle, we talk fantasy…not reality or execution.

The main and only game in town for the markets is the US inflation measure. The Consumer Price Index clearly shows that it only comes back in an economic/market crash and soon after that it goes back on the merry way higher. 

We are talking about nearly 70 years of data. It’s been through a few cycles. The hyperinflation of the 70s is clearly separate from the post-WWII cycle of the 50s and 60s. The interest rate cycle peaked in the 80s and fell for the next 40 odd years. 

CPI has run up almost in a straight line with an average annual rate of around 5.5% for 40 years. The US Fed has been able to manipulate the sales pitch through the years to create a Core CPI that barely moves to justify rate cuts when it should not have been done. That being said, the simple fact is that CPI never had a decade of pullback. Not even a five-year cycle. 

Economists will claim automation with technology etc will reduce cost and drive lower inflation. Costs do go down over time. And inflation will eventually subside to lower levels. That does not mean that the average person is paying less. Even a transient rise in inflation for six months means costs are at a much higher base than before and they are not coming back.

Every corporate in the capitalistic market tries to reduce cost via different avenues so it can improve margins and profits to attract a higher share price. But they are not incentivised to pass that on to the customer in the form of lower prices without real competition trying to steal market share. If there is anything that is clear in the US economy as an aggregate is that there is very little competition and all the cost savings are going into corporate profits and almost nothing is being passed on over the last 70 years. 

If you are expecting prices to fall in the next decade without a economic crash, then you still believe in fairy tales!!! Economist and Strategist living in ivory towers with classic economic models have lost touch of the real world. In the real world, government gives fake policies to boost profits of big donor corporates that dominate market share due to weak regulation.

The annual inflation rate in the US soared to 4.2% in April of 2021 from 2.6% in March and well above market forecasts of 3.6%. It is the highest reading since September of 2008, amid a surge in demand as the economy reopens, soaring commodity prices, supply constraints. There is also a base effect weighing as the coronavirus pandemic dented economic activity bringing the inflation rate to 0.3% in April 2020. The biggest increases were recorded for gasoline (49.6% vs 22.5% in March), fuel oil (37.3% vs 20.2%) and used cars and trucks (21% vs 9.4%). Inflation also accelerated for shelter (2.1% vs 1.7%) and new vehicles (2% vs 1.5%) and rebounded for apparel (1.9% vs -2.5%), but slowed for medical care services (2.2% vs 2.7%) and food (2.4% vs 3.5%). Meanwhile, compared to March, prices rose 0.8%, the most since 2009 while monthly core consumer inflation increased 0.9%, the most since 1996.

Now the question would be….but US Fed looks at Core Inflation?….well the data looks even worse. It’s hitting a 24-year high!

US core consumer prices, which exclude volatile items such as food and energy, rose 3.0% in April 2021, its largest annual increase since January 1996 and well above market consensus of a 2.3% advance.

Now US Fed is not going to raise rates. They want to…but they can’t because there are massive debt bubbles holding major parts of the economy together. It is going to take an extremely tricky dance between fiscal and monetary policy to not move a hot inflation cycle into a hyperinflation cycle. Fiscal policy needs to keep printing to keep the majority of the economy funded while monetary policy needs to absorb the excess bond supply. This all needs to happen without triggering USD debasement and market panic. We may be at the end of the “Central Bank Put” cycle. Will the US Fed risk hyperinflation hitting the economy to save the markets? Time will tell.

Comments on US market last close

The US market was bashed on inflation data beating expectations on nominal and core levels. The market is realising that this is only going to keep rising and that means costs are rising everywhere and they are not going to come back. DOW -1.99%, S&P -2.14%, NASDAQ -2.67% and RUSSELL -3.26%. Bond yields were on a rip with the 10-year hitting 1.7% and USD popping. AUD/USD pulled back with commodities while Oil remains positive on pipeline hack and Middle East geopolitics. The energy sector was the only green zone while Retail and Tech were belted the most. There will be a lot of options unwinding and margin calls going to be made over the next few weeks. 

  • The VIX is a broken-down trend. 
  • Aussie banks are jamming up fixed rates. 
  • China is warning about asset bubbles and high commodity prices. 

Spot Gold in A$ is the only shining light. 

We have been pushing investors to buy inflation hedge in bear ETFs and Aussie Gold miners ahead of this cycle. Expect the reflation cycle to pick up steam. Expect geopolitics to increase as fake budgets gets governments into economic mess. We may be seeing the beginning of the end of the Central Bank put. Time to get off the fence and play aggressive defence or watch performance fade by thousand cuts.

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Mathan Somasundaram
Founder & CEO
Deep Data Analytics

Over 25 years’ experience in the finance/tech industry. Mathan has worked extensively in all parts of the finance sector (i.e. County NatWest, Citi, LIM, Southern Cross, Bell Potter, Baillieu Holst and Blue Ocean Equities). Currently Founder and...

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