Long awaited by investors around the world, the Consumer Price Index (CPI), an index that measures retail inflation in the United States, negatively surprised the market. The Bureau of Labor Statistics (BLS), a US government entity similar to our IBGE, announced last week that the CPI for October had risen by 0.9%. With that, the inflation accumulated in 12 months until October advanced to 6.2%. It was the highest level in exactly 31 years, since 6.3% in October 1990. This result was far above the experts’ forecasts, which were 0.4% for the month and 5.8% for 12 months.
According to economic theory, inflation above expectations should trigger shock waves in the markets, as investors anticipate a tightening of monetary policy. In other words, higher interest rates and a reduction in the stock of money. The consequences are also known. Assuming a rise in US interest rates, Treasury bonds are expected to rise, anticipating the rise in the cost of money. Shares were expected to decline due to expected decline in corporate earnings. And the dollar should appreciate against other currencies. Higher rates make investments in dollars more attractive, international capital flows to the United States and the exchange rate appreciates.
Despite the negative surprise of rising prices, there was a positive surprise, the weak reaction of the markets. Ten-year US Treasury yields rose, but the rise was short-lived. Stock indexes fell, but at the end of the day the devaluation was less than 1%. And even the exchange rate of the dollar against other currencies fluctuated less than expected. How to explain this?
Again, back to the textbook. Several decades ago, US authorities realized that the prices of some items, such as food and fuel, fluctuate a lot due to the momentary noises of supply and demand, and this adds extra volatility to the indices. To reduce this effect and give more clarity to price trends, statisticians developed indices that follow the “core inflation”, or “core index”, which do not consider food and fuel prices. And in this case, inflation is lower.
The “core index” of the CPI in the 12 months to October is at 4.6%, well below the 6.2% of the “full” index. The difference occurred because in the last 12 months, fuel prices in the United States rose 30%, gasoline became 49% more expensive and fuel oil, essential for heating and transport, saw prices rise by a stratospheric 59%. Conclusion: much of the increase is due to the increase in oil prices.
It is no coincidence that the rates are at the same levels as they were 31 years ago. In September 1990, Saddam Hussein, Iraq’s bloodthirsty dictator, had invaded neighboring Kuwait with an eye to an outlet and the emirate’s vast oil reserves. The American reaction led to the Gulf War, which sent oil prices soaring and pressured inflation. After the scare, prices returned to previous levels and inflation dropped.
Something similar is happening now, but without war. The gap between supply and demand has driven a barrel of oil to the highest prices in decades, with the barrel topping $82, and that isn’t likely to adjust any time soon. Thus, the cause of inflation is not the traditional overheated economy, but a mismatch in the supply of a specific product caused by extra-economic decisions: an oligopoly defending its profit margins at the expense of consumers. And that is why a tightening of monetary policy by the Federal Reserve is not justified. When oil demand and supply adjust, which should happen in 2022, the pressure on prices will ease.
And that goes for inflation in Brazil too.
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