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Printed: 02 April 2023 10:35 PM


29 Mar 2022 - The central bank dilemma

By: Kardinia Capital

The central bank dilemma

Kardinia Capital

March 2022

Jerome Powell's re-election as Federal Reserve chair late last year was a relief to investors, but a few short months later his credibility is now on the line.

As economists continue to argue as to whether inflation is transitory or permanent, political parties know full well that inflation is disastrous at the ballot box. The US midterms will be held in November and polling doesn't look good for the Biden administration. While the 2024 full term election is still a while away, inflation is rising. Gasoline price increases are toxic to the US voter and the prices at the pump are already at record levels, recently surpassing the 2008 spike. CPI is almost certainly going to be north of 8-9% year on year over the next few months, which is going to light a fire under the Fed. 

12-month percent change in CPI for All Urban Consumers (CPI-U),
not seasonally adjusted, Feb 2021 - Feb 2022


Source: U.S. Department of Labor

Inflation is taking off, but the outlook for the global economy remains uncertain. China has just announced a GDP growth target of 5.5% this year, the lowest in more than 30 years. Russian credit has just been downgraded to junk, while global sanctions are already creating material market distortions.

Meanwhile, the effects of higher oil prices are rippling across the economy. We believe those prices are here to stay, due largely to geopolitical events and ESG trends.

Russia is the world's largest net exporter of oil and gas combined. According to Goldman Sachs, Russia supplies 11% of global oil consumption and 17% of global natural gas consumption (and as much as 40% of Western European consumption). However, the US has banned the import of Russian oil and gas, the UK is phasing out oil imports by the end of 2022, and the EU announced plans to cut imports of Russian gas by two thirds within a year.

The world needs to replace this supply, but OPEC has already announced that it has no plans to increase production in response to the Russia/Ukraine war. US trade envoys have been dispatched to Venezuela, with suggestions that a Saudi Arabian trip is in the planning. Of course, the US has the potential to bridge some of the shortfall by ramping up its own unconventional production; however, that appears unlikely given the US administration was elected on a clean energy platform.

Energy supply was already under pressure from ESG trends. In 2020, BP announced a plan to cut oil and gas production by 40% over 10 years and pivot towards renewables. Last year, Shell announced that its oil production had peaked and would fall 1-2% per annum as it targeted net zero emissions by 2050. This supply shortfall is occurring just as energy demand is returning after the COVID-induced lockdowns of the past two years. There is no easy solution. We do not believe there will be a quick end to the Russia/Ukraine conflict, meaning energy and commodities prices will remain elevated. The resources and energy sectors should generate attractive returns in 2022, with Australia in the box seat to outperform the rest of the world given its stable, resource rich environment.

It's also worthwhile watching the credit and debt markets, which are so deep and more liquid that equity markets (and often equity investors) overlook the signals these markets provide. The 2yr/10yr year US yield curve is flattening, with credit markets signalling that investors are losing confidence in the economy's growth outlook. Often it can be difficult to predict the trigger for an economic downturn, but in this case it could be the Fed raising the federal funds rate itself that causes a downturn. 

Funds operated by this manager:

Bennelong Kardinia Absolute Return Fund

The content contained in this article represents the opinions of the author/s. The author/s may hold either long or short positions in securities of various companies discussed in the article. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the author/s to express their personal views on investing and for the entertainment of the reader.
This information is issued by Bennelong Funds Management Ltd (ABN 39 111 214 085, AFSL 296806) (BFML) in relation to the Bennelong Kardinia Absolute Return Fund. The Fund is managed by Kardinia Capital, a Bennelong boutique. This is general information only, and does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units in any fund of which BFML is the Trustee or Responsible Entity (Bennelong Fund). This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser. You should also consider the relevant Information Memorandum (IM) and or Product Disclosure Statement (PDS) which is available on the BFML website,, or by phoning 1800 895 388 (AU) or 0800 442 304 (NZ). Information about the Target Market Determinations (TMDs) for the Bennelong Funds is available on the BFML website. BFML may receive management and or performance fees from the Bennelong Funds, details of which are also set out in the current IM and or PDS. BFML and the Bennelong Funds, their affiliates and associates accept no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. All investments carry risks. There can be no assurance that any Bennelong Fund will achieve its targeted rate of return and no guarantee against loss resulting from an investment in any Bennelong Fund. Past fund performance is not indicative of future performance. Information is current as at the date of this document. Kardinia Capital Pty Ltd (ABN 20 152 003 186) is a Corporate Authorised Representative of BFML

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