The challenge of supply-driven inflation
When inflation rises to 7.5%, as it has in the U.S., it inevitably becomes a big issue. But it is the particular causes that make the current upward pressure on prices so special, and perhaps intractable – a sticking point especially for central banks. The U.S. financial house Neuberger Berman illuminates the situation.
Tighter monetary policy won't bring truck drivers or factory workers back to their jobs. It is not providing additional storage capacity, faster container ships or more efficient ports so that the backlog can be relieved. However, Michael Barr of Neuberger Berman's equity research team concludes in his data analysis that, unlike in past inflationary periods, these are precisely the factors currently driving up prices.
Current inflation is often said to be supply-driven, not demand-driven. Neuberger Berman takes a fundamentally similar view. But he also says there is nothing wrong with seeing the reasons on the supply and demand side equally.
Logistics capacity is not keeping up
Much of the price shock appears to be related to the triumph of e-commerce during the pandemic. There is simply not enough logistics capacity. According to the U.S. Census Bureau, online retail in the U.S. grew by over 32% in 2020, but warehouse space grew by only 2%.
Truck capacity is also barely keeping up with new demand. And at about $15,000 per 40-foot container (FEU), average ocean freight rates are now ten times higher than before the pandemic. According to the futures markets, freight rates will still be over $8000 in 2024.
"Even if you want to pay that much, freight unloading could fail", says Neuberger Berman. Normally, there are about 15 to 20 ships anchored off U.S. West Coast ports. At the beginning of the year, it was over 100. Since then, the congestion has eased somewhat due to seasonal factors, but still the queue is unusually long. Whether things will normalize soon is hard to gauge.
Rising prices bring monetary policy risks
These are all reasons why U.S. producer price inflation in January was above expectations and the adjusted mean of consumer price inflation (excluding the largest price changes in either direction) is higher than at any time since surveys began in 1983. It's not just energy and used cars – used car prices are up 37% in 2021 – but the imbalance of supply and demand throughout the economy.
So far, businesses and consumers haven't been too rattled yet. For example, financial data provider FactSet reports that as many as three-quarters of S&P 500 companies mentioned inflation in their fourth-quarter conference calls. Still, estimates of net profit margins for the current year have not changed. You seem to rely on your pricing power. The surprisingly strong rise in U.S. retail sales in January suggests companies are not overestimating themselves.
"But with each week that prices continue to rise, the monetary policy risks for investors grow", Joseph V points out. Amato, president and CIO equities at Neuberger Berman. Time and market forces will eventually dampen inflation, but current supply constraints could cause problems for years to come in some cases.
If moderate rate hikes don't curb inflation, it has more to do with ships in the roads than excessive spending. Perhaps the Fed is risking tightening too quickly to dampen inflation a bit. The U.S. Treasury's bond team, however, sees things differently and expects a measured approach, given the complex mix of temporary and structural inflation drivers: But if the market draws different conclusions, volatility looms, Amato says.
And even if the Fed does the right thing for the U.S., it doesn't have to do the same for other countries. In effect, the Federal Reserve is the central bank of the world. Perhaps, however, the monetary policy appropriate for the U.S. is too tight for other countries.
Although energy price increases are likely to hit Europe the hardest because of the Ukraine conflict, supply constraints are greater in the U.S. for a number of reasons. For example, few jobs were cut in Europe during the pandemic as large-scale short-time work was used. In contrast, unemployment benefits were increased in the U.S. "Perhaps that's one reason for the imbalances in the U.S. labor market and the big "staffing shortages", speculates Amato.
For example, when the World Bank and IHS Markit unveiled their new Container Port Performance Index last year, the most efficient U.S. port was Philadelphia at No. 83. Los Angeles was ranked 328 out of 351. The top ranks included havens in Asia, the Middle East and North Africa. The most efficient European port was Algeciras in Spain in 10th place.
Common Rules: Halma or chess?
All of this suggests that Asia and Europe could tolerate more expansionary monetary policy than the U.S., the U.S. investment strategist says. The ECB could thus prevent a massive increase in peripheral spreads. The Bank of Japan could achieve that the economy continues to grow as it did last year, the first year of growth since 2018. China could also dampen the downturn. The People's Bank of China is currently easing monetary policy, while the Fed prepares to tighten.
For Neuberger Berman, these are the arguments why investors are paying so much attention to inflation, its causes and Fed pronouncements. But if the central bank only focuses on the demand side, while supply factors are the focus for the economy, there could be problems in the U.S., but also globally. "It can't go well if one plays halma and the other plays chess", according to Neuberger Berman. It's one of the reasons the U.S. asset manager expects volatility to continue this year.