Tag Archives: inflation

A closer look at Inflation

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By Alizay Fatema, Associate Portfolio Manager, BMO ETFs

(Sponsor Content)

While inflation was sidelined by several central banks and deemed as “transitory” for the most part during 2021, the tone shifted promptly this year as back-to-back red-hot inflation prints forced most central banks to go on an interest-rate hiking spree. This aggressive action is being taken to tame inflation otherwise known as the rate of change in prices over time, [1], as it’s persistently high and is eroding the purchasing power of households, reducing consumer spending, and the overall economic well-being.

What are the causes of inflation?

Before we discuss whether inflation will slow down or not, let’s take a step back and analyze what’s causing prices to rise globally in the first place. Most economists attribute this uptick in inflation to several different causes such as:

  • Cost-push inflation driven by supply chain crisis

The COVID-19 outbreak led to a series of lockdowns and restrictions across the globe, which caused supply chain disruptions and labour shortages and ultimately induced cost-push inflation [2], resulting in a surge of prices due to an increase in costs of producing and supplying products and services. World economies are still recovering from this effect, and some of these constraints are fading away as global transportation costs plunge and Chinese production ramps up again. However, the Russian invasion of Ukraine is clearly hampering this progress and further stoking inflation.  [3]

  • Demand-pull inflation fueled by savings, fiscal stimulus, and monetary policy

The pandemic had caused an unconventional recession, and to keep economies afloat, several central banks slashed their interest rates, increased their money supply M2 (a measure of the money supply that includes cash, checking deposits, and easily- convertible near money)., gave out government aid, relief, & stimulus payments as part of the fiscal response during 2020 & 2021. As businesses reopen this year after remaining shuttered and reducing their production and services, they could not meet the pent-up demand driven by savings accumulated during the pandemic along with the monetary & fiscal stimulus. Thus, strong consumer demand, fueled by robust growth in employment, has outstripped supply temporarily for several products & services such as air travel, hotels, cars, etc., resulting in demand-pull inflation [4].

 

A series of interest rate hikes to curb sky-high inflation

The price increases for gasoline, food, and housing caused Canada’s inflation to rise to a 39-year high of 8.1% in June 2022. The markets got some respite in August as headline inflation came down to 7% and further weakened in September to 6.9% from a year ago, as gasoline prices fell. However, the recent data was disappointing as the dramatic increase in food prices was unexpected.

On a similar note, south of the border, the U.S. inflation spiked to 9.1% in June 2022, the highest level since 1981. Although headline U.S. inflation reported for September was up by 8.2% from a year earlier (down from the peak of June 2022), the core U.S. consumer price index (ex. food & energy) rose to a 40-year high, increasing to 6.6% from a year ago, which is a cause of concern as its squeezing households by outpacing the growth in wages.

To dial down the surge in prices, the Federal Reserve engaged in a series of rate hikes not seen since the late 1980s, increasing the front-end interest rate to 3.25% in September. The Bank of Canada followed suit by raising rates through consecutive outsized hikes, bringing its target overnight rate to 3.75% in October. Given inflation is still sky-high in both countries and way above their 2% target, both Fed & Boc are expected to raise their short-term rates again. Both central banks are maintaining their hawkish tones, which means the rates will be further raised to fight against raging inflation. However, they may dial back the pace of their hikes amid recession fears.

When will we see a slowdown in inflation?

Looking at recent CPI prints, the question arises whether the U.S. and Canada have passed peak inflation. The truth is it’s hard to predict what lies ahead. Prices in some sectors, such as gas and used automobiles, have dropped, which is a good sign. However, prices for certain goods & services are “stickier” than others, such as rent, insurance, health care or dining out, meaning that they are likely to stay at their current levels or increase even further, so inflation may stick around for a while. Moreover, higher wages and inflation may continuously feed into each other, resulting in a wage-price spiral [5] which may result in further rate hikes, causing additional damage. Continue Reading…

High inflation in 2022 changes calculus on delaying CPP till 70

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Actuary Fred Vettese had a couple of interesting (and controversial!) articles in the Globe & Mail recently that may give some near-retirees  who were planning to defer CPP benefits until age 70 some pause.

The gist of them is that because of inflation, those nearing age 70 in 2022 might want to take benefits sooner than later: despite the almost-universal recommendation of financial pundits that the optimum time to start receiving CPP (or even OAS) benefits is at age 70. From what I glean from Vettese’s analysis, those who are 69 this year should give this serious consideration, and possibly those who are currently 68 (or even 67!)  might also think about it.

You can find the first piece (under paywall, Sept 27) by clicking the highlighted headline:  Thanks to a Rare Event, Deferring CPP until age 70 may no longer always be the best option.

The second, quite similar, article ran October 6th:  Deferring CPP till 70 is still best for most people. But here’s another quirk for 2022, when inflation is higher than wage growth.

Certainly, Vettese’s opinion carries weight. He is former chief actuary of Morneau Shepell (LifeWorks) and author of several regarded books on retirement, including Retirement Income for Life.

My own financial advisor [who doesn’t wish to be publicized] commented to his clients about these articles,  noting that they:

“aroused interest among some of you on when to begin receiving the Canada Pension Plan (CPP) given an unusual wrinkle that has occurred over the past couple of years where it may be more beneficial  to not defer it to 70 in order to maximize the dollar benefit.  It is particularly relevant for those who are within a year or two of approaching  70 years old and have so far postponed receiving CPP … My take on the piece is that if you are not receiving CPP and you are closer to 70 years old than 65, then the odds move more favourable to taking it before reaching 70. That is particularly true if there are health concerns that affect longevity.”

I must confess that I found Vettese’s thought process hard to follow all the way, but I respect his opinion and that of my advisor enough that it altered our own CPP strategy.  People who had originally planned to take CPP  at age 70 early in 2023 may be better off jumping the gun by a few months, opting to commence CPP benefits late in 2022. This is because of a unique “quirk” in the Canada Pension Plan that is occurring in 2022, whereby “price inflation is higher than wage inflation.”

Personally, I took it at age 66 (3 years ago) but we had planned to defer my wife Ruth’s CPP commencement till 70, still about 18 months away. Vettese himself turns 70 in late April [as do I] and in an email he clarified that because of the inflation quirk, he’s taking his own CPP in December: 5 months early.  But as his example of Janice below demonstrates, even those a year or two younger may benefit by doing the same.

A lot is at stake with such a decision, however, so I would check with your financial advisor and Service Canada first, or engage a consultant like Doug Runchie of DR Pensions Consulting, to make sure your personal situation lines up with the examples described in the article.

2022 is the exception that proves the rule

Actuary and author Fred Vettese

Vettese starts the first article by recapping that CPP benefits are normally 42% higher if you postpone receipt from age 65 to age 70. However, he adds:

“Almost no one knows – and this includes many actuaries and financial planners – that the actual adjustment is not really 42 per cent; it will be more or less, depending on how wage inflation compares with price inflation in the five years leading up to age 70. It turns out this arcane fact is crucial. The usual reward for waiting until 70 to collect CPP is that the pension amount ultimately payable is typically much greater than if you had started your pension sooner, such as at age 65. In 2022, that won’t be the case. As we will see later on, someone who is age 69 in 2022 and who was waiting until 70 to start his CPP, is much better off starting it this year instead.”

Those most directly affected are people over 65 who have not yet started to collect their CPP pension. Here’s how he concludes the first article:

“In a way, 2022 is the exception that proves the rule. It is the result of COVID, a once-a-century event, creating a one-year spike in price inflation without a corresponding one-year spike in wage inflation. This analysis, by the way, has no bearing on when to start collecting the OAS pension.

This should send an SOS to financial planners and accountants, as well as retirees who take a DIY approach. Deferring CPP will usually continue to make sense but not necessarily in times of economic upheaval.”

In an email to Fred, he sent me this: “I wouldn’t spend too much time on the Wade example (first article). Situation is rare. More common is the Janice example (second article). It applies just as I state in the article.”

Example of those turning 68 early in 2023

For the Janice scenario, Vettese describes someone currently age 67 who had planned to start taking CPP benefits in April 2023, a month after she turns 68: Continue Reading…

Planning in uncertain times: How inflation is pressuring Canadian businesses to meet employee expectations

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By Elizabeth English, Mercer Canada 

Special to the Financial Independence Hub

The squeeze inflation is putting on businesses and their employees alike is being felt around the globe. As employees and their families deal with the increasing cost of living, employers are under pressure as they manage compensation budgets and salary expectations for the next year and beyond. Employees have heightened expectations of a commensurate pay increase with lower purchasing power. Employers must respond or risk losing talent.

As businesses grapple with the best ways to retain existing employees and attract new hires, Mercer released its 2023 Compensation Planning Survey, compiling data from more than 550 organizations of varying sizes across 15 industries. The survey reveals a number of insights for employers and employees alike.

Most companies are just beginning to think about increase budgets

With the price of everything from gas to groceries on the rise, there is an expectation from employees that their compensation should keep up with rising costs. Many organizations are in the early stages of deciding how to respond; the Survey shows that as of August, only 5 per cent of organizations had approved increased budgets, 11 per cent had proposed increases, and 84 per cent were still in preliminary stages.

Budgets continue to rise

Inflation is causing Canadian employers to increase their compensation budgets. Heading into the upcoming year, employers surveyed are budgeting an average of 3.4 percent for merit increases and 3.9 per cent for total increase budgets in 2023. This puts merit and total budget increases up from 3.1 per cent and 3.4 per cent, respectively, from 2022. However, even with these raises, merit and total increases fall short of year-over-year inflation, which hit a 40-year high of 8.1 per cent in June, moderating to 7.6 per cent in July and 7.0 per cent in August.

Across Canada, the highest increases in total budgets are in Montreal (4.5 per cent), Greater Edmonton (4.3 per cent), Saskatchewan (4.2 per cent) and Greater Calgary (4.1 per cent). With compensation budget increases falling well short of inflation, organizations across Canada will need to focus on managing employee expectations. This can be done through their internal communications, planning for multiple scenarios, as well as adopting a more comprehensive and broader total rewards perspective to attract and retain talent.

Off-cycle increases are being used for a variety of reasons

Historically, inflation isn’t the top metric for shaping compensation strategies. Still, in this high inflation environment, 34 per cent of organizations are considering ad-hoc, off-cycle wage reviews or adjustments to combat turnover. This is a significant hike from 19 percent considering the same in March of 2022. Continue Reading…

Defined Benefit pensions lagged in third quarter but continue to withstand volatile markets and historic inflation: Mercer

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Unlike the first half of 2022, the financial position of most defined benefit (DB) pension plans “decreased slightly” in the third quarter, as they were buffeted by inflation and volatile stock markets. Investment returns were mostly negative in the quarter, and yields on long-term bonds were lower at the end of the quarter than they were at the beginning, according to The Mercer Pension Health Pulse (MPHP), released on Monday.

The MPHP tracks the median solvency ratio of the DB pension plans in Mercer’s pension database, which decreased from 109% as at June 30, 2022, to 108% as at September 30, 2022.

Of the plans in Mercer’s pension database, at the end of Q3:

  • 72% of plans were estimated to be in a surplus position on a solvency basis,(vs. 73% at the end of Q2)
  • 17% of plans were estimated to have solvency ratios between 90% and 100%,(vs. 16% at the end of Q2)
  • 5% have solvency ratios between 80% and 90% (unchanged from Q2), and
  • 6% have solvency ratios less than 80%. (also unchanged from Q2).

In a press release, the Calgary-based Principal and leader of Mercer’s Wealth business, Ben Ukonga,  said that “In spite of the significant market volatility, the financial health of most DB plans would have experienced only a slight decline in the third quarter of 2022. As for what can be expected for the remainder of the year, plan sponsors should continue to expect significant volatility.”

Mercer says experts “urge caution and encourage plan sponsors to be prepared for anything, with more volatility on the horizon. Markets will most likely remain volatile in the short to medium term due to numerous risks such as the continued war in Ukraine, the upcoming US midterm elections, the potential confrontation between the US and China over the status of Taiwan, risks of a global energy supply shortfall, and of course, the ongoing inflationary environment.”

Continued short- and medium- term volatility

Markets will most likely continue to remain volatile in the short to medium term due to numerous global risks, including the war in Ukraine (and the Russian Government’s actions in response to Ukraine’s recent successes on the battlefront, such as the recent annexation of parts of Ukraine in violation of International Law, and the geo-political fallouts from these actions). Mercer is also cautious about the upcoming US mid-term elections, the increasing political gridlock and polarization in the US, and the potential for a confrontation between the US and China over the status of Taiwan. The recent volatility in the UK currency and bond markets and the risk of contagion to other markets.

Mercer also sees risks from a global energy supply shortfall, and the effect such a shortfall would have on the global economy: “… plan sponsors should pay attention to the risks associated with energy insecurity in Europe – such as the risk of the Russian Government using Russian gas supplies against Europe in retaliation to sanctions on Russia, and the effects on European economies if their energy supplies are curtailed.”

Inflation at levels not seen in 30 years

With inflation running at levels not seen in over 30 years, central banks globally are “on an aggressive monetary tightening mission in order to get inflation under control. Will they succeed without triggering a hard-landing global recession? Will higher interest rates make governments, corporations and households unable to meet the interest payments on debts they accumulated during the very long period of low interest rates? This could lead to an increase in bankruptcies and crowding out spending and investments, further exacerbating the risks of a hard landing global recession.”

As workers see a decline in the purchasing power of their wages, there will be increased pressures on employers for higher wages, Mercer says. “Sponsors of indexed DB plans will see increases in the cost of these arrangements, and sponsors of non-indexed DB plans may face pressure from their pensioner groups to provide ad hoc cost of living adjustments. Coupled with labour shortages, some employers may have no choice but to increase their labour costs. And companies that are unable to pass these increased costs to their customers will face profit margin pressures and reduced profitability, hurting their future economic outlook.”

Covid still poses macro risk

The global health landscape also poses a macro risk, Mercer says. “As the western hemisphere is entering the winter months, will a new vaccine-resistant strain of the COVID-19 virus appear? And how will governments and citizens deal with such a resurgence? Will the Chinese government continue with its zero-COVID policy? And how much of a negative impact will this policy, along with what some would call draconian lock down measures, have on the Chinese economy? And how deep will the negative knock-on effects be on China’s trading partners?” Continue Reading…

Avoid new issues but high-quality stocks likely to gain in value over next year

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The IPO or “Initial Public Offerings” market — more commonly known as the new issues market — has gone through an extraordinarily bad time this year. It’s been bad for all three of the groups that take part in this market. They are as follows:

Investors who put their money in new issues have lost substantial sums in the past year. On average, new stock issues tend to do worse than the rest of the market in their first few years of public trading. This past year, they performed much worse than ever.

Financial institutions that bring new issues to market for sale to investors have suffered, too, because demand for new issues has dried up. At this time of year in 2021, the new issues market had raised around $100 billion. So far this year, it has raised just $5 billion. In the past quarter century, the new issues market raised an average of $33 billion at this point in the year.

Companies that raise capital for themselves through the new issues market are suffering as well. When the new issues market began drying up as a source of corporate funding, many would-be issuers of new stocks found it was harder and more expensive than ever to find alternate sources of financing.

This will be worst year for IPOs since 2009

This will be the worst year for raising money in the new issues market since 2009, when the economy was struggling to pull out of the 2008/2009 recession.

As long-time readers know, we generally advise staying out of new stock issues. After all, there’s a random element in the success or failure of every business, especially when it’s just starting out. But new issues expose you to a special risk that you avoid with stocks that have been trading publicly for some time. That is, you can only invest in new issues when they come to market.

This is just one more example of a conflict of interest, which we’ve often referred to as the worst source of risk you face as an investor.

Companies only come to the new issue market to sell their stock when it’s a good time for the company and/or its insiders to sell. The insiders can’t predict the future, of course. However, they do know much more than outsiders do about their company. Continue Reading…