Inflation prompts reset

Rising inflation is creating a headache for governments and citizens alike in Jamaica’s major trading partner countries, particularly the United States.

It’s also fuelling pass-through price increases along the still-problematic supply chain, all the way to the purses and pockets of Jamaican consumers. Inflation in the local economy continues to bust the 4 to 6 per cent statutory range, reaching 8.5 per cent in October before moderating to 7.3 per cent in December.

Whether COVID-19-induced shortages or the Democrats’ more than US$5-trillion stimulus spending, or a combination of both, are to be blamed for America’s 40-year-high inflation level of seven per cent in December, the fact is that the imported knock-on effect for small, open, import-dependent economies like Jamaica is significant.

Central bankers’ fix to prevent or cauterise runaway inflation is by no means painless for the consuming public, as the preferred tool of indicative interest rate increases makes credit cards, mortgages, car loans and other loan-driven spending more expensive. Those who didn’t make these kinds of purchases, preferring to conserve cash and wait and see, like most people were doing in the first two years of the pandemic, are likely to either miss the boat or pay dearly.

There were early miscalculations by economists and central bankers, who initially misread market indicators, and in the process, underestimated the pervasiveness of the inflationary triggers, the entrenchment of inflation expectations and thus, the persistence of the price rises. The upshot is that consumers, monetary policy authorities and investment managers are now resetting purchasing decisions, expectations and approaches.

Robert Stennett, deputy governor heading the research and economic programming division, and in charge of financial stability at the Bank of Jamaica, BOJ, has echoed his bosses’ concession that the local central bank’s initial calculations did not anticipate the seven per cent realms the US inflation numbers reached in December.

“The impact of monetary and fiscal policies in the US was expected to lead to wage pressures and, hence, temporarily to inflation in that economy. This forecast envisaged that annual point-to-point inflation in the US would peak at approximately 6.0 per cent in the December 2021 quarter. Inflation in the US, however, rose to 7.0 per cent in December 2021 from 2.3 per cent in December 2019, the highest rate over the past 40 years,” Stennett said in a written response to Financial Gleaner queries about the BOJ’s gauging of US inflation and recalibration of monetary policy based on the less-than-transitory reality of high prices overseas and, hence, in Jamaica.

The central bank economist reiterated BOJ expectation now for domestic inflation, driven in part by the acceleration in inflation among Jamaica’s main trading partners, including the US, to remain above the target range, at least until the second half of this calendar year.

The latest prognosis, however, is for a significant falling off of the US inflationary trend.

“The most recent outlook was for US inflation to average 3.5 per cent to 4.5 per cent over the next eight quarters in a context of persistent supply constraints. Based on the bank’s macroeconomic model, a one percentage point increase in inflation in the US results in an increase of 0.1 to 0.3 percentage point in domestic inflation within a year,” said Stennett.

Citing implications for investors and fund managers, the central banker noted that the anticipated increase in interest rates in the US will widen the interest differential between assets held in Jamaican dollars and those held in US dollars. With the US Federal Reserve expected to yank rates upwards up to four times for the year, starting as early as next month, the central banker suggested that BOJ is acutely aware of the possible negative currency implication. The Federal Reserve, or Fed, is the US central bank.

“(It) could adversely affect the foreign exchange market if domestic monetary policy is not properly aligned,” Stennett said.

There was some speculation that the BOJ, in raising rates as early as September last year, was, at least in part, pre-empting capital flight to more attractive US bonds and equities once rates began to rise there, thus delaying disequilibrium in the currency market that would accompany such investor moves.

“We continue to favour longs in energy and reopening sensitive sectors versus more broad generic risks, especially into the first half of 2022. We see US 10-year yields ranging between 1.75 per cent to 2.5 per cent over the course of the year, reflecting these factors,” Sean Newman, executive vice-president and chief investment officer of Sagicor Group Jamaica Limited, said of his company’s investment management stance, given the US inflation and pending rates hikes.

Newman believes it is more important to focus on inflation expectation than on inflation itself. He said given recent indications that supply chain constraints are easing, it is Sagicor’s expectation that demand will rotate back towards services rather than manufactured goods, and that inflation would moderate considerably throughout 2022 as a result.

“Surveys point to inflation peaking in Q1 2022 at 6.6 per cent, declining to 3.0 per cent by Q4 2022,” he said, via email, to the Financial Gleaner. “For 2023, consensus US consumer price index is at 2.4 per cent versus 4.7 per cent in 2021, above the Fed target, leaving upside risks to our US rate view,” he added.

Ramon Small-Ferguson, executive vice-president for asset management and research at Barita Investments Limited, the shift in interest rate policy, with new rate increases aimed at tamping down inflation, could lead to a change in the structure and profile of preferred investments.

“In terms of how we look at pricing the uncertainty around inflation into transactions, on the fixed income side, I think you may see the return of some floating rate-type structures. Because of the general downward direction of rates (prior to the inflation uptick in 2021), most structures have tended to carry a fixed rate over the course of the past eight to 10 years. You may see a return of floating rate-type notes, and you may also see greater appetite for non-traditional assets that provide natural hedges against inflation, like real estate and infrastructure,” Small-Ferguson said in an interview with the Financial Gleaner.

He added that infrastructure projects like toll roads and power plants tend to have built-in contractual rate increases that are tied to inflation, giving investors added confidence that their returns will not be eroded by price increases.

“These are embedded inflation hedges, so you may see increased demands for those types of exposures; as well as, when you drill down to the real sector, which would be benefiting potentially from increased prices, you may see sections of the equity market doing better,” he said.

Small-Ferguson is nevertheless advising caution in the current climate, noting that inflation in the US is in territory that’s been unfamiliar for the past 40 years. The US is tracking five percentage points above its 2.0 per cent inflation target, while Jamaica has breached its upper band by 1.3 points.

The Barita executive telegraphed confidence in the Jamaican monetary policy authority’s ability to keep the situation under control.

“The net international reserves are very strong. The financial services sector is very robust, even as we have come out of a pandemic. So, I think the BOJ will have several tools at its disposal to keep things in check,” Small-Ferguson said.

huntley.medley@gleanerjm.com