Bullion Bulletin: Farewell, soft landing

As recently as mid-2020 the US central bank, the Federal Reserve, was ‘targeting’ inflation – i.e. trying to ensure inflation was – 2% a year. Whoops – the Consumer Price Index (CPI) in March came in at 8.5%, the fastest pace of inflation in 40 years.

The Fed, like all central banks, has two main tasks – achieving price stability while maintaining maximum employment. It’s clearly failed on the first and is in danger of bringing about failure for the second.

The Fed wants to bring about what’s called a ‘soft landing’, a slowdown in the economy such that high inflation is choked off while unemployment does not increase beyond tolerable levels. The trouble is that the Fed is caught between a rock and a hard place.

Inflation has much further to go, thanks to Russia’s invasion of Ukraine, a ‘black swan’ (unexpected and unpredicted) if ever there was one. The World Bank has said that the world is now facing “the largest commodity shock… since the 1970s…[which] is being aggravated by a surge in restrictions in trade of food, fuel and fertilizers”. It reckons that energy prices will rise more than 50% and agriculture and metals’ prices will go up almost 20% this year. Countries are starting to adopt protectionist measures, restricting exports of key products – Indonesia this week banned exports of palm oil. Sunflower oil exports – of which Ukraine leads the way – are evaporating, increasing demand for alternatives such as palm oil, a key ingredient in everything from lipstick to cookies to biodiesel. Higher palm oil prices are dragging up prices of alternatives, such as soyoil. Supermarkets in the UK have started limiting cooking oil purchases. The Commodity Research Bureau (CRB) Index, a basket of 19 commodities, has more than doubled since the US emerged from pandemic lockdowns.

In other words, there are plenty of reasons to think that there is so much momentum backlogged into inflation prospects that – even if peace broke out tomorrow in Ukraine – consumer prices will carry on inexorably rising. In the face of this, what can the Fed do? The conventional method of tackling inflation is to push interest rates above the inflation level, to make money and credit more expensive, and (it is hoped) that will discourage spending. But consumers in the US, the UK, the Eurozone, have so long lived with interest rates at or close to zero that getting to around 10% will be politically difficult and economically destructive – a massive recession would swiftly follow. “Nine times since 1961, the central bank [the Fed] has embarked on a series of interest rate increases to rein in inflation. Eight times a recession followed”. Let’s not forget the political dimension to this – the Democrats in the US will face testing mid-term elections later this year and inflation is bound to be a hot-button issue.

It’s starting to feel as though we are in for a repetition of the 1970s, when stagflation – elevated price increases combined with stagnant economic growth – was an all-too familiar word. According to some commentators, a stagflationary environment creates the perfect combination of factors to drive strong performances in both gold and the dollar – both of which are seen as defensive assets at times of economic stress, such as now.