SCOREBOARD: Commodities puzzler

Commodities remain outlying underperformers in an otherwise strong market, while inflation forecasters gear up for debate.

Well once again it seems that equities have managed to push higher and in some cases by a good margin, with the S&P500 up 0.9 per cent and the Nasdaq up 1.3 per cent, athough the Dow was only 0.1 per cent higher. Things were admittedly a little more mixed in Europe but not bad overall, with the Dax down -0.2 per cent, the CaC up 1.5 per cent and the FTSE 0.7 per cent higher.

For the week then, and after Friday’s moves, the S&P500 was down only 2 per cent or so which means it's off 2.5 per cent from its record high, what, about 10 days ago now. That doesn’t seem too bad I don’t think, but it certainly makes moves in the commodity space over the same period all the more odd – gold is down 11 per cent, copper about 8 per cent and crude 6 per cent, just for the week.

Now, there wasn’t a lot of data for the session, so most of the momentum derived from positive earnings reports from Google and Microsoft, and maybe just a rebound following a soft week. It wasn’t one-way traffic though on the earnings front and some key blue-chips like IBM and McDonald's disappointed. For equities, suffice to say, it’s probably more the case that confusion reigns at this point – no capitulation as yet.

Against that backdrop I don’t think it’s going to be a massively exciting week for us. For today the SPI suggests our stocks will see gains of 0.2 per cent. Then for Australia it’s an ANZAC day shortened week anyway. Prior to that memorial day we see consumer price data on Wednesday at 1130 AEST.

We’ve heard a lot about inflation lately and there has been a big PR push on the subject. The aim is to convince people that inflation is low, to anchor inflation expectations. Unfortunately it is untrue though. Inflation is not low and investors need to realise this.

The problem is the debate has been distorted. Commentators try to make out that because we don’t have hyperinflation, then inflation is low. It’s a stupid benchmark and a disingenuous one. Instead, when an economist tells you that inflation is low, ask them why inflation, in advanced economies over the last two years, has averaged more than what we saw in the decade to 2004. In fact, average inflation rates now are only slightly lower at 2.4 per cent than what we saw in the four years building up to the global financial crisis (2.6 per cent). Inflation was widely regarded as a growing problem then – the inflation genie, people, do you remember it?

Now, with similar inflation rates, Ben Bernanke and Paul Krugman et al suggest that inflation around the world is nothing to worry about and the fact we don’t have hyperinflation now proves it. These are vacuous comments in my opinion, from people who should know better. We were never going to have hyperinflation now, that was never the concern or argument.

I suspect some are having a bit of a go though which is why they use such outlandish comments. I mean these people had been arguing, and some of them still do, that deflation was and is a threat – it was always implausible. Others are just trying to jawbone, manage inflation expectations and the like as inflation accelerates. That’s the global backdrop.

With that backdrop though and in the Australian context, inflation forecasters (myself included) have had an equally bad track record. We all thought inflation would subside in the wake of the financial crisis and it didn’t. Instead it accelerated. Inflation has subsequently declined, but I think Australian economists have missed the cause here and they have confused some temporary factors impacting the results with a permanent structural change. Fools rush in, etc.

Now, I would be more relaxed by the numbers if it weren't for a few facts. Firstly, we’ve all been wrong over the persistence of domestic inflation, and that is the real paradigm shift. Inflation persistence is actually the problem we are seeing around the rest of the world I would note as well. The models that people like Krugman and Bernanke use can’t explain that phenomenon – they just ignore it and pretend it isn’t happening. But I think the facts have shown that economists, and that especially goes for some big bauble-wearing global economists, don’t understand inflation dynamics anymore. They have failed to adapt to our dynamic world.

For us, headline and core inflation rates are modest – just above 2 per cent on the official measures, including the core measures. However, these low rates mask what is quite clearly a worrying persistence in inflation. We do see it though, most clearly in the non-tradeable inflation index, which is still around 4 per cent.

Why are headline rates so low then? Well, the major reason is that food price growth is the lowest it has ever been on record. This isn’t what we are seeing globally and indeed food prices are on the up. I don’t think it’s a big call to suggest that ongoing weakness here is unsustainable when food prices are going up, sometimes sharply, everywhere else.

The second reason is obviously the dollar. Now, while the dollar may still be high and may not be coming down for a while, you actually need it to keep rising to continue putting downward pressure on inflation. If it doesn’t, the impact wanes. Well, it’s been steady for a while now.

If you take out those two temporary items, inflation isn’t so low here.

So anyway, for the March quarter numbers we get this week, the consensus is that headline rose 0.7 per cent and core 0.5 per cent. This would give annual rates of 2.8 per cent and 2.4 per cent.

That will probably be the key focus for the domestic market this week to be honest, as there isn’t a lot going on globally data-wise. We get housing data for the US (existing and new home sales), durable goods and another GDP estimate on Friday night, although we still have some US earnings to come.

Hope you have a great week…

Adam Carr is a leading market economist.

Follow @AdamCarrEcon on Twitter.

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