Dutch inflation is to cry

US inflation fell for the fourth consecutive month in October. The decline was stronger than expected. This led to gigantic movements in the financial markets. The idea behind all these moves is that inflation is apparently starting to come under control and the Fed won't need to raise rates much further as a result.

The first picture shows the effective yield on ten-year US Treasuries, say US capital market rates, over the past five days. After the publication of the inflation figures on Thursday afternoon, this interest rate fell in a short time from 4,1% to 3,8%. That's a really huge move.

In the wake of the US bond market, capital market interest rates in the Netherlands also fell, but much less sharply. With us, the effective yield on ten-year government bonds fell from 2,45% to 2,30%.

Effective yield on XNUMX-year US Treasuries

The second picture shows the price of the Nasdaq. The stock markets are having a bad year because interest rates have risen so sharply and a recession may be on the way. The Nasdaq mainly contains 'growth' stocks, which are more sensitive to interest rates than other stocks. The chart shows that the Nasdaq rose no less than 7,5% after the publication of the inflation figures.

Nasdaq

Inflation figures also had a major effect on the foreign exchange market. The prospect of lower interest rates in the US with the outlook for European interest rates unchanged pushed the euro back above parity against the dollar.

These are truly historic movements. The movement seems logical, but still quite large. What's going on here now? If the turning point in inflation has indeed passed and US inflation is now rapidly approaching 2%, then the move may be justifiable not only in direction but also in magnitude. But it could also be that market participants were simply extremely relieved by the numbers or that all kinds of automated trading systems started moving en masse.

Regardless, US inflation fell from 8,2% in September to 7,7% in October. Core inflation also fell slightly, although the chart shows that you cannot yet say that a clear decline has already started.

I don't think they get off that easy
I am optimistic that inflation will fall more sharply in 2023 than many expect. Still, I don't see the October figures as a sign that the time has come. Normally, it takes a considerable cooling of the economy to significantly limit very high inflation. If US inflation were already on course towards 2%, you have to conclude that the Americans will get off it quite easily. I can't imagine that. And don't forget that the price level in October still rose by 0,44% compared to September. If this pace is maintained for twelve months, inflation will still be around 5,5%. The year-on-year decline in October was mainly due to prices rising by 0,9% in October last year. So there is a base effect.

Nevertheless, lower inflation is very welcome and I think the downward trend will continue. Ultimately, sharply reduced international freight rates and reduced logistics disruptions will contribute to the normalization of prices. In the past two years, many prices have risen disproportionately and then you can expect a normalization, ie a decline. Used cars, for example, have become significantly more expensive in the last two years, but are now cheaper again. In the last three months, those prices have fallen by almost 7% and I think that's just the beginning.

I have written many times about the importance of rents in US inflation. The story is simple. Actual housing rents and imputed rents to homeowners make up about 32% of the US inflation basket (with us about 22%). And in the basket of core inflation even about 40%. Rents in the US follow house prices, albeit with a time lag that varies. In October, the rate of increase in rents increased further: from 6,7% in September to 6,9%. The following chart shows that the rate of increase in house prices is now decreasing. With some delay, the increase in rents will therefore decrease. But that will only take shape in the course of 2023. When that happens, inflation will slow down in the US quickly.

I cry tears with spouts
Dutch inflation also fell somewhat in October. According to the national measure from 14,5% in September to 14,3% in October. According to the European HICP measure, inflation in our country has fallen from 17,1% in September to 16,8% in October, as was already published last week. Despite the drop, it still brings tears to my eyes. The comparison is undoubtedly flawed, but in Brazil inflation has been falling for months now. After peaking at 12,1% in April, inflation came in at 6,5% in October, less than half our rate! Unimaginable! And that while you always associate Brazil with much higher inflation than with us.

If I still have tears left, I also dare to look at energy prices. Then I immediately burst into tears. I do know that the figures on our energy prices show an overestimation of the bill actually paid by families because many people still have permanent contracts, while Statistics Netherlands only looks at new contracts. As families run out of their permanent contracts, this will naturally correct itself. Statistics Netherlands is working on an alternative calculation method. As the figures are now in the books, the price increase of energy in our country is 100%, in Germany 43% and in the US 18%. What have we done wrong, what have we done to deserve this?

Optimistic about next year
This week's macro news has been dominated by US inflation data as they have caused such a massive move in financial markets. I have been optimistic for some time that inflation will fall faster next year than many foreseen. So are the recent US numbers right? Only partially. A reduction in logistics disruptions and lower freight rates contributed to falling inflation in October. But my optimism about next year is partly based on the expectation that a recession will occur. If this is not the case, I don't think we will go to 2% very quickly.

I can only cry about the Dutch inflation. Not only is it insanely high, but a comparison with other countries also suggests that our inflation is unnecessarily high. Isn't it time for policymakers to submit to some self-critical scrutiny?

Oh yes, the international economy does not make me any happier. Chinese and Korean trade figures suggest that world trade is currently under considerable pressure.

And oh yes, inflation in Russia just keeps falling. It was almost 18% in April and has since fallen in a straight line to 12,6%. Not that I'd rather live in Russia, but it does make me think.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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