A few weeks ago, I shared why I think the worst could be over soon as far as inflation, interest rates and the peso are concerned.
Today, I am more convinced that inflation and interest rates will soon trend lower due to the following reasons:
Commodity prices continue to go down. In fact, the price of industrial commodities such as copper is now below end-2021 levels, while the price of oil is close to pre-Ukraine war levels even though the conflict with Russia continues. With prices of raw materials used in the production of goods going down, there is less pressure for manufacturers to increase selling prices and for workers to demand higher pay.
The US economy is also slowing down. Earlier this month, S&P Global disclosed that the Flash US Composite PMI (Purchasing Managers’ Index) fell to 47.5 in July from 52.3 in June. Note that a reading below 50 signifies contraction.
Both the Flash US Services Business Activity Index and the Flash US Manufacturing Output Index were very weak at 47 and 49.9, respectively, both two-year lows. Excluding the pandemic lockdown months, these are levels not seen since the global financial crisis in 2009.
Another indicator that the US economy is weakening is its second quarter gross domestic product falling 0.9 percent, after contracting by 1.6 percent in the first quarter. This could potentially mean that the United States is in a recession. Softer demand should weaken companies’ ability to increase prices, helping cool inflation.
Global central banks are also turning more hawkish, raising rates to defend their currencies amid a very aggressive Fed. After the United States disclosed that June inflation further accelerated to 9.1 percent, the Bangko Sentral ng Pilipinas announced an off-cycle 75-basis point rate hike, surprising the market. Other global central banks also raised rates, with the European Central Bank increasing rates by a larger-than-expected 50 basis points for the first time in 11 years.
Falling commodity prices coupled with signs of slower economic growth and central banks’ resolve to fight inflation are convincing more and more investors that inflation will soon trend lower.
This is the reason why the 10-year bond rate both in the United States and in the Philippines fell significantly last week even though the Fed raised rates by a fresh 75 basis points. The greenback also weakened despite the Fed action, allowing the peso to close below P56 last week after depreciating sharply the past two months.
Given more convincing signs that inflation and interest rates will soon trend lower, now is a good time to buy fixed income assets such as bonds and real estate investment trusts (REITs) to lock in higher yields. However, stick to high quality bonds and REITs as slower economic growth will hurt the ability of some issuers to pay their obligations. INQ