Central banks around the world are engaging in very accommodative monetary policy. Negative real interest rates are the norm right across both developed and developing markets. This is a large part of why commodity prices are rising so rapidly. It is also a major reason that gold and silver are hitting new highs.
Gold futures for June delivery hit $1477.50 an ounce this morning while silver for May delivery was up at $42.715 per ounce. Speculation is certainly a factor. But people are also looking for protection against inflation as inflation expectations have risen dramatically due to accommodative interest rate policy and rising food and commodity prices. The question is whether these inflation expectations are realistic. Cullen Roche pointed to a David Rosenberg chart demonstrating that whenever US inflation expectations hit the 6% mark, official measures of US inflation actually fell.
But inflation is not just a US problem now, it is everywhere. Real interest rates are negative in the US, the UK, and in the Eurozone as well. In India, data released today showed the inflation rate accelerated to 8.9% in March. Yet, base interest rates set by the central bank remain at 6.75%, making yields negative 2.15%. That’s painfully accommodative. In China, we see the same easy money policy where data released today show inflation has accelerated to 5.4%.
Win Thin, head of Emerging Markets Strategy at Brown Brothers Harriman wrote this morning in a note that also appeared on Credit Writedowns:
So far, we have seen 100 bp of lending rate hikes that started in October 2010 and 450 bp of reserve requirement hikes that started in January 2010. During the previous tightening cycle, hikes were 189 bp and 1000 bp, respectively.
Given that the mainland economy remains very strong, we would characterize PBOC policy as still moderately accommodative and behind the curve, and suggest that another 75-100 bp of rate hikes and 550 bp of reserve requirement hikes at least could be seen in 2011, with risk to the upside in terms of tightening potential. Fears of a hard landing will surely rise, but we do think that China policy-makers still have time to set things right but action is needed soon. Real lending rate remains at an ultra-low 0.7% in March, much too low for this stage of the business cycle.
In Latin America, inflation is also rising. In Chile, interest rates at 4.5% are barely above the inflation rate of 4.3%. But in Brazil, real rates of about 5% are very high compared to Asia and elsewhere in developed markets. This has attracted a lot of capital and has increased the Brazilian currency and asset markets. Bill Gross has said explicitly that he is looking to emerging economies because of negative real yields in the US. Brazil is front and center in the currency wars for this reason.
Labour markets are tightest in emerging markets like Chile, Brazil, India or China. So the risk of wage-price inflation accelerating upward are greatest there. This would naturally feed through into commodity prices, food and exported goods. So the developed economies are not off the hook by any stretch here. In fact, the easy stance of developed economy central banks is driving money into emerging markets and fostering the accommodative stance of those central banks, fearful of more hot money flows or currency appreciation. Easy money in the face of rising inflation is at the heart of the now subdued currency wars. This battle has moved to inflation and potentially to demand destruction. That is why gold and silver are rising so prodigiously. Unless central banks demonstrate that they have the stomach for counteracting this inflation, more money will continue to flow to precious metals.