Peak inflation?

As our head of multi-asset investments David Coombs balks at the cost of a couple of cups of coffee, he explains why he thinks inflation may be getting close to peaking.

Two coffee cups

I like to support local businesses so last Saturday I walked round to the village sports club (football, tennis and bowls, you know the sort of thing) as a new coffee kiosk had opened up. It’s run by our local farmer and called Dora’s Dairy (though his name is John).

It wasn’t quite as swanky as Jeremy Clarkson’s Diddly Squat enterprise, but I applaud John’s entrepreneurial spirit nonetheless. Tracey duly ordered two skinny flat whites before I could intervene to save her from ridicule. Unlike me, she had an urban upbringing and expected the farmer to be offering numerous milk choices. I’m just glad she didn’t ask for oat milk.

The point of this little window into my rural life is that the price of a full-fat flat white was £3. Yes, £3! That’s inflation run rampant. I know we’ve breached the £3 barrier at the likes of Costa and Starbucks, but I’ve already cut back on them. It’s not because I can’t afford these prices, but there comes a point when you start to question the value of what you’re paying for.

Customers of the world’s biggest retailer Walmart seem to be making similar calls about what they think is prohibitively expensive. Walmart’s latest results highlight that their customers are switching out of spending on discretionary general merchandise to focus on food and consumables. You might think “OK, one sets off against the other.” Unfortunately, that’s not the case. The margins on general merchandise are higher (which is why so many supermarkets sell the stuff). Walmart has gone on to state that they’ll need to discount the prices of this unsold merchandise to reduce their inventories.

Is the Fed tuned in to warning signs?

Let’s hope US Federal Reserve (Fed) chair Jerome Powell is hearing all this. Walmart is a bellwether stock that’s sounding a loud warning bell. Higher energy and food prices are starting to act as a restraint on growth. How long before Americans aren’t just refraining from buying Halloween masks at Walmart, but holding back on bigger ticket items like cars and holidays?

All this feels like we’re near, if not at, peak inflation. Commodity prices have headed lower recently, stabilising at around February levels. I acknowledge, of course, that this trend could reverse at any time given the huge amount of geopolitical instability swirling around at the moment.

But surely the Fed’s latest 0.75% rate rise should be the last for a while as it pauses to gauge the impact of recent hikes and changes in consumer habits on the broader economy? I’m not sure the US economy can take many more rises. And the developing world could certainly do with a break from a rising dollar.

Of course, the Fed doesn’t have a mandate to support developing world economies. But ambivalence about the pain inflicted by a strong dollar will probably only push developing world governments closer to China for financial support, so the White House may well hold a pretty forceful view about further rate hikes and dollar gains.

I may be guilty of confirmatory bias, but I’m sticking with my view that rates will peak below 4% and probably closer to 3.5%. The bond market kind of agrees with me. This view continues to drive our multi-asset funds’ short term asset allocation.

For now, it’s back to tea with the vicar. That costs £1 and you get a biscuit (although those wanting almond milk may be disappointed). He also happens to live next door so I save on my shoe leather too!

Tune in to The Sharpe End — a multi-asset investing podcast from Rathbones. You can listen here or wherever you get your podcasts. New episodes monthly.