We tend to believe what we want to believe and act accordingly.

As Schumpeter put it: “the way in which we see things can hardly be distinguished from the way in which we wish to see them”.

Or Greenspan’s theme of 2008: “human nature’s propensity is to sway from fear to euphoria and back”.

If the bet pays off, good and well. If it doesn’t, course corrections follow.

For the past five weeks worldly perceptions have been thoroughly sold on a global growth slowdown impressive enough to pull down the commodity pillars.

And locally the perception has taken hold that inflation will be racing down next year, foremost because StatsSA will be reweighting CPIX, in the process lowering inflation by as much as three percent.

This local perception is further fed by the global condition, pulling oil and food prices down, causing an even more fundamental collapse in the inflation spike than projected by StatsSA doings.

It is as if our collective inflation turbos are reversing thrust.

Fever has been broken

Whereas for years the global growth was good, the commodity demand/supply balance tight and of late the consequent inflation explosive, market participants are increasingly voting that this fever has been broken.

Indeed, so virulent is the reaction that not only US growth is seen as slow, but other regions such as Europe and Japan are seen as slowing even more, to the point of entering recession.

This relative change in performance makes the US now look half respectable, in the process boosting the dollar, impressively even, improving to 110 yen and 1.47 euro, improvements of 7-15 percent since the dollar’s low point earlier this year.

Locally, the inflation build-up this past year was so vigorous that no end was any longer visible to the acceleration, though logically first-round commodity price shocks cannot keep intensifying indefinitely.

Commodity bears had stuck to their guns, but were long ignored. And the coming StatsSA weight changes to CPIX calculations had long been signaled, but apparently never really absorbed by financial markets.

Until mid-July, when in close proximity to each other both these pivotal aspects became abruptly highlighted, and more importantly discounted in market perceptions.

The oil price started falling like a stone from a $147 all-time high, today already below $110 and pulling other commodity prices along with it, gold dipping below $800 and platinum below $1400.

And suddenly everyone was mentally knocking three percent off the CPIX, courtesy of the coming weight changes, because that became rapidly the received wisdom.

And as the oil price decline gathered momentum, and key agricultural commodity prices also turned weaker, led by corn and guided by improved global weather conditions in key producing regions, the rout was getting to be complete, as visibly reflected in our long-term bond yields declining.

Real or all make-believe?

But is it for real or all make-believe? Is this ultra-short term thinking or has it staying power, even if only cyclically?

Participants in the global oil market have taken it long as an article of faith that demand was expanding more strongly than supply, with inventories low, reserve production capacity far too limited for comfort, and longer term even bigger supply problems looming.

That, too, was ultimately perception, on which huge financial bets were made, with in their wake higher investment portfolio allocations following.

Once this world view became shaken by US motorists driving less over the summer, growth stalling in especially the richer countries, and rumours as always flying about weaker growth in the poorer regions, with oil supply possibly more flexible than thought, the system was ripe for a perception change.

Also it didn’t help that the US Congress in recent months made angry noises about the role of speculation driving up oil prices unnecessarily, and threatening market intervention. More importantly perhaps, the US credit and banking problems may have started to starve liquidity for funding commodity futures.

Whatever the combination of events, it seemed to have created a tipping point, which started rolling the ball downhill faster than what it ever had raced uphill.

Not that this had not been forecasted by some prescient oil analysts, and specifically long foreseen for 3Q2008. But they simply had not been believed, indeed ignored, as the greater market wished to push one set of ideas, until perception crucially broke.

This doesn’t necessarily mean that the longer term price reality in oil and commodities generally has genuinely fundamentally changed for the better. But that short-term perceptions have, and with it commodity price action, seems to be the case.

So virulent is this latest global mind change that not even Russian military aggression towards Georgia, in more receptive times perhaps good for adding another $10-$50 to the oil price, could upset perceptions as the global oil market kept disgorging disgruntled bets and fear drove the sell side.

Could this change again one day?

It seems a fair bet, given Greenspan’s diagnosis of the human condition, the world’s growth prognosis led by the East, and commodity supply constraints identified longer term, that this condition will again change some day.

Buy side froth is being blown away

But for now the buy side froth is being blown away, and is the world apparently prepared to go underweight commodities, heavily even, in terms of portfolio positioning and thereby price.

The consequences are staggering. There has been this explosive rise in inflation, led by oil but bolstered by food. These past ten months it has mobilized central banks to a degree that was fearful, as rising interest rates emphasized voluntary growth sacrifice.

But ultimately it worked, reinforcing an old adage. Don’t fight the Fed. Except that the Fed this time merely made a few aggressive noises once or twice, only to backpedal.

It was left to the ECB and especially smaller central banks in Australasia and emerging markets to follow through aggressively with rate tightening. It certainly must have made an important contribution to breaking the global commodity fever.

Presumably, the follow-through will turn out to be equally awesome ere long. Central banks may eventually also start backpedaling into rate cutting before the paint has dried on the new fashion of falling commodity prices, inflation, bond yields and inflation expectations.

Our local convictions have seemingly undergone a similarly radical conversion. The inflation fever has broken. Inflation is going to abruptly fall.

Not that all our risks have suddenly gone away.

An important global fallout

One important global fallout, the sudden firming of the dollar, became last week reflected in an abrupt weakening of the rand, in days losing over 60 cents from 7.20:$ to beyond 7.80:$. But it was mostly dollar buy-effect rather than convinced rand sell-effect.

Still, with a nine percent of GDP current account deficit we can’t act too lightly about currency risk and its implications for inflation, a lesson well-learned during previous rand attacks.

So there will presumably be lingering risks and concerns, as also highlighted last week when the SARB released the Monetary Policy Committee decision to keep interest rates unchanged for now. Oil and rand were singled out as uncertain risks going forward.

But with our growth sacrifice well advanced, CPIX inflation set to implode on current trends, and global latent risks (oil, food, US financial crisis, rand) receding for now, there is reason to feel relieved.

Our interest rates have reached elevated levels. Indeed, South Africa seems to be conducting a high interest rate defence of its macro stability. The next policy move is presumably down if the worldly perceptions hold, and the SARB is prepared to buy in.

Apparently this is now no longer a matter of whether rates may be cut, but when.

Cees Bruggemans is FNB's chief economist.


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